One of the first decisions that entrepreneurs need to make when starting a new venture is the type of business structure to choose. There are several types of business, including sole trader, partnership, limited company and limited liability partnership. In this article we discuss what is meant by a sole trader and the potential challenges and financial considerations of this type of business.
We will also explore why, in most cases, a limited company provides a better option for those starting up and running a business in the UK.
Introduction to Sole Traders
“Sole trader” is one of the simplest forms of business structure and is often adopted by self-employed individuals. As the name suggests, sole trader businesses are owned and operated by just one person. Small business owners typically choose to become sole traders because of the lower legal formality, administration and costs. It is important to note that sole traders do not necessarily need to work alone and can hire employees as necessary.
Understanding the Concept of a Sole Trader
Becoming a sole trader is widely perceived as being one of the easiest ways to become self-employed in the UK. The process of setting up as a sole trader is quick and requires little in the way of administration. As we will discuss later, however, it is now quick and easy to set up a new limited company that is registered at Companies House.
Sole traders are personally responsible for running their businesses and making any business decisions. They also have few legal obligations, do not need to split any profits among other shareholders and own all of the assets of the business.
Self employed individuals may need to set up as a sole trader if they:
- Have earned more than £1,000 from self-employment in the last tax year;
- Need to prove that they are self-employed (e.g. to claim Tax-Free Childcare) and:
- Want to make voluntary National Insurance contributions.
Alternatively, as we will shortly explain, it is now quick, easy and affordable to set up a limited company, offering greater overall benefits.
Key Characteristics of a Sole Trader Business
There are several key characteristics of a sole trader business, some of which we have already mentioned elsewhere, as follows:
- No legal separation: As a sole trader, there is no legal separation between the business and its owner so that, together, they form one single legal entity. This means that the owner may be legally exposed to claims against the business and any losses incurred. This is different from a limited company, whereby the business and its owner are completely separate legal entities and, hence, the owner enjoys limited liability.
- No separation between management and ownership: Sole traders own all the assets of the business (e.g. vehicles, tools and machinery) and have complete control over how the business is run.
- Unlimited liability of participators: Sole traders are personally liable for all of the business’s debts and other liabilities. Crucially, there is no personal limit on any business debts and liabilities.
- Number of owners: A sole trader businesses can have only one owner.
- Minimal statutory formality and obligations: As a sole trader, there are few business formation formalities or initial statutory filing requirements.
- Business Constitution: Sole trader businesses require no constitutional documents such as articles of association (which are required for limited companies).
- There are no ongoing filing requirements. Sole traders are not required to file statutory documents with Companies House (e.g. annual accounts).
Legal Framework for Sole Traders in the UK
Sole traders operate within a simple legal framework as follows:
- Legal liability: Sole traders run their own businesses and there is no legal separation between the owner and the business itself.
- Tax: Sole traders only need to register with HMRC for self-assessment and pay income tax and National Insurance on their profits.
- Regulatory compliance: The overall regulatory requirements for sole traders may be less than for large companies. It is still important, however, to ensure adherence to any applicable regulations (e.g. health and safety law).
- Contracts: Sole traders can still enter into business contracts and recruit staff members.
Advantages of Operating as a Sole Trader
Operating as a sole trader offers a number of distinct advantages for individuals who seek to run their own business in the UK, as follows:
- The process of setting up a sole trader business is relatively simple and cost-effective. There is no need for sole traders to go through a registration process, so this reduces the initial administrative burden and associated costs.
- Sole traders have complete control and autonomy over their businesses. They can make any decisions independently, including those relating to business strategy and day-to-day operations. This allows greater agility when responding to market needs and changes.
- Sole traders enjoy high levels of flexibility because they can quickly and easily change their business strategy, operational model and industry – or even cease operating – with no need for complex legal formalities.
- Sole traders can keep all of the profits made by the business after tax. This can then either be reinvested into the business or used as personal income.
- Taxation for sole traders is relatively straightforward. Sole traders need to file only a single self-assessment tax return each year. There are also tax advantages, including being allowed to claim business-related expenses.
- Sole traders have greater levels of privacy compared with limited companies. There is no requirement to have personal details placed on any public register which, in sharp contrast, is mandatory for all directors of limited companies.
Potential Challenges Faced by Sole Traders
Although there are advantages to being a sole trader, it is important to understand also the challenges that are presented. Sole traders often struggle to secure financing to run or expand their businesses simply because they cannot sell shares to raise capital. This can impede future business growth and expansion. Furthermore, sole traders cannot enjoy the considerable tax advantages and efficiencies of limited company ownership.
As we have already discussed, sole traders are personally responsible for their business. The effect of this is that their personal assets (e.g. their home) are at stake if their business falls into debt or incurs legal liabilities.
Another key consideration is the workload faced by sole traders. Because sole traders take on sole responsibility for the business, including the strategy, marketing, sales and operations, this can – over time – become overwhelming. If it is not managed then the personal workload of a sole trader can lead to burnout.
Sole Trader: Advantages and Disadvantages
How to Register as a Sole Trader in the UK
To establish a legally compliant sole trader business in the UK, the following steps should be completed:
- Choose a business name – a sole trader business name must not:
- Be offensive.
- Contain “limited”, “Ltd”, “limited liability partnership”, “LLP”, “public limited company” or “plc” at the end.
- Contain a “sensitive” word or expression.
- Be a registered trademark.
- Register with HMRC for Self Assessment: This is how sole traders declare how much tax their business owes each year.
- Prepare and submit a self-assessment tax return to HMRC each year.
- Retain all business invoices and receipts.
- Pay all tax that you owe to HMRC by the deadline given.
- Register for VAT (see below for more details).
Tax Responsibilities of a Sole Trader
HRMC Self-assessment
Sole traders are required to register with HMRC for self-assessment tax and National Insurance. This can be done on the HMRC website with a Government Gateway ID and a Unique Taxpayer Reference (UTR).
Once registered for self-assessment, a Self Assessment tax return must be prepared and submitted to HMRC every year. Any personal income tax and National Insurance must then be paid by the deadline provided.
The current rates of income tax are as follows:
| Band | Taxable income | Tax rate |
| Personal Allowance | Up to £12,570 | 0% |
| Basic rate | £12,571 to £50,270 | 20% |
| Higher rate | £50,271 to £125,140 | 40% |
| Additional rate | over £125,140 | 45% |
Value added tax (VAT)
VAT registration is mandatory if a sole trader meets the VAT threshold. At the time of writing, the VAT rules state that a sole trader must register for VAT if they think their annual total of VAT taxable turnover will exceed £85,000 p.a. within the next 30 days.
How to Manage Finances as a Sole Trader
To manage finances effectively as a sole trader, it is important to:
- Keep separate personal and business bank accounts. This allows sole traders to track their income and expenses accurately.
- Keep accurate records – including invoices, receipts and business expenses.
- Create a budget to manage cash flow effectively and ensure the financial stability of the business.
- Set reminders for tax payment deadlines and set aside money for any taxes owed, including VAT and income tax.
- Engage a trusted accountant who can manage the business’s finances and accounts.
Transitioning from Sole Trader to Limited Company
With professional support, switching from a sole trader to a limited company in the UK can be completed quickly and smoothly. The main steps are as follows:
- Come up with a unique company name.
- Register the company so that it is incorporated at Companies House.
- Inform HMRC of the change.
- Register with HMRC for Corporation Tax and PAYE.
- Transfer any business assets and liabilities to the new company (e.g. property, machinery, equipment and stock).
- Open a new business bank account for the company in its own name.
- Update any contracts, licences, agreements and website with the new company details.
- Notify customers and suppliers about the change in business structure.
Self-employed or limited company: Which is right for you?
Conclusion
Many self-employed people choose to become sole traders because of the perceived complexities and administrative overheads of running a limited company. This is despite the huge benefits offered by limited company ownership, such as full legal separation and tax advantages. The reality is that setting up as a limited company makes better sense, even for very small businesses, and can now be quicker and easier than ever. Uniwide Formations can register and incorporate your new company within one day at an affordable rate. Furthermore, we make meeting your annual filing requirements as straightforward and efficient as possible.
