Becoming a sole trader in the UK is the most important structural decision that you can make when starting a business in this dynamic market. Especially if you are a freelancer, small business owner, self-employed professional or looking to experiment with a new entrepreneurial idea. As the most accessible, quickest and simplest business structure in the UK, it offers you several benefits and advantages.
If you are thinking of becoming a sole trader in the UK, here’s a brief guide on everything you need to know.
What Is a Sole Trader?
In the UK, a sole trader is also called a ‘sole proprietor’. In this simplest form of business structure, as the name suggests, there’s a single owner of a business having complete control over it. Unlike a limited company, a sole trader is not a separate legal entity.
- You get to keep all the profits of your business while also being responsible for the business debts.
- You are in complete control of your business, a single owner and independent to make any decision.
- You don’t need to register your business with Companies House but with HMRC, which is usually free of cost.
- You are personally liable for business inefficiencies, i.e. your personal assets are not immune to unpaid business losses/debts.
- You need to file your Self-Assessment Tax for the business you own; there is no need for corporate taxation.
- You and your business are considered the same; there’s no legal distinction when it comes to finances.
Who becomes a sole trader in the UK?
A sole trader is the best business structure for small business owners and self-employed professionals in the UK. This typically includes:
- Freelancers (writers, designers, developers, and other skilled professionals)
- Consultants.
- Tradespeople (plumbers, electricians, carpenters, etc.)
- Small-scale retailers.
- E-commerce businesses.
Registration process as a sole trader
As a sole trader in the UK, you need to register your business with HMRC under the self-employed category. You can do this till 5 October of the 2nd tax year since starting your business. Sole traders must keep all of the financial records, i.e., income and expenses, and submit an annual Self-Assessment tax return as per the official dates set.
Advantages
Choosing to become a sole trader comes with its unique set of benefits and advantages for the business owners. Such as;
Low-cost, minimal setup
Sole proprietorship brings low-cost, minimal setups that don’t require incorporation fees, complex structures or registration with Companies House. You can just register with HMRC for free.
Complete control
As a sole trader, you have complete control over your business decisions and operations. You don’t need to have board approval, deal with shareholder conflicts or become confused in decision-making.
Keep all profits
Sole proprietors get to keep all of the business profits after tax deduction as a single owner.
Simple accounting
Sole proprietorship comes with simple accounting expenses to track your finances and file tax returns each year. No need to hire an accountant, just invest in appropriate accounting software.
Privacy
Sole traders don’t need to publicly disclose their financial accounts, thus offering greater privacy and business confidentiality.
Flexibility
As a sole trader, you can enjoy flexibility in starting/stopping your business operations anytime. Plus, you have the free will to change business directions as per your needs and market demands without legal complications.
Disadvantages
There are several disadvantages of becoming a sole trader in the UK as well. For example;
Unlimited liability
Since in a sole trader business and business owner has no separation, there’s unlimited liability. This means a business owner is liable to all of this business’s debts, losses and/or claims with his personal assets. As the most significant disadvantage of a sole proprietorship, your assets and savings are always at risk.
Limited funding
Since sole traders operate on a small/local level, it’s harder for them to secure funding through business loans or investors. This affects your business’s ability to raise capital.
Harder to build market credibility
Sole traders don’t have as much credibility and market reputation as limited companies. As a result, you may face challenges securing big contracts or impressing clients.
More responsibility
As a sole trader, you take on more responsibility because you have to handle everything. Accounts, finances, procurements, operations, transport, sales, marketing, customer support, etc.
No business continuity
If you stop working as a sole trader, your business automatically stops because there’s no legal separation between the two.
Tax inefficiency
Sole traders might end up paying high taxes at higher income levels that result in tax inefficiencies. For example, you may be required to pay Income Tax on all profits and also pay National Insurance contributions.
Taxes
Understanding how taxes work for sole trader sis essential for your business financial literacy. There are different types of taxes that a sole trader is liable to pay.
Income tax
As a sole trader, you end up paying income tax on your profit and not your revenue, which can go up to 45% of your income.
NICs
Sole traders are also required to pay NICs (National Insurance Contributions). In this regard, there are two categories;
- Class 2 NICs, if your profits exceed £12,570, a flat rate of £3–£4 per week.
- Class 4 NICs are based on profits that can cost ~9% on profits between £12,570 – £50,270, while ~2% for profits above that.
VAT
You must register for VAT (Value Added Tax) if your business’s annual turnover exceeds £90,000. After registration, you are responsible for charging VAT on your goods/services and submitting VAT returns, + keep its records.
MTD
The UK government is slowly implementing its Making Tax Digital (MTD) policy for income tax. This means Digital record-keeping will become essential for sole traders who may require quarterly updates to HMRC.
Tax return
Sole traders file for Self-Assessment Tax return every year by 31 October (paper filing) and 31 January (Online return + tax payment).
Allowable expenses
You can save on your tax expenses by legally deducting all business expenses. It includes payments for your office supplies, Travel costs, marketing and advertising expenses, cost of Equipment and tools, as well as Home office expenses (if any).