Last Updated: Apr 02, 2024

Advantages and Disadvantages of Becoming a Sole Trader [Comprehensive]

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🔑 Key Takeaways

  • As you prepare to launch your business with confidence, one of the most pivotal decisions you face is selecting a company structure that best aligns with your interests.
  • A sole trader is a self-employed person who operates their business as an individual. The business and the owner are considered the same legal entity
  • Limited companies have multiple financial reporting requirements compared to sole traders, including filing annual accounts with Companies House.

In this article, we explore the process of establishing yourself as a sole trader while assessing its advantages and disadvantages. As you navigate the early stages of your business journey, you’ll also find a valuable comparative analysis with other structures, such as limited liability companies.

What is a sole trader?

A sole trader is a self-employed entrepreneur who owns and manages a company as an individual. Also known as a sole proprietorship, the trader has unlimited liability since the business is not legally distinct from the owner. The solopreneur can operate in their name, using personal assets and resources.

As the sole company manager, a sole trader can make independent decisions without the formalities often associated with partnerships or corporate structures. Such autonomy allows them to experience the positive outcomes of their choices directly.

However, it’s important to note that such independence comes with a crucial trade-off—personal liability (responsibility) for adverse consequences such as debts, losses, or legal obligations incurred by the business.

Personal liability means that the owner’s assets, such as property or savings, are at risk in the event of business-related financial challenges.

Read: Limited Liability Partnerships

Advantages of Being a Sole Trader

As mentioned earlier, setting up as a sole trader may include advantages such as increased flexibility and the freedom to structure the whole operation to align with your unique approach to business. Additional benefits include —

  • Easier and more cost-effective — As a sole trader, you do not need to register your business with Companies House. All you have to do is inform HM Revenue and Customs that you are operating as a sole trader by enlisting for their online services and will pay your taxes through self-assessment tax return.

  • You keep all the profits — Since the business is yours, and you operate by your name, you get to keep all after-tax income. In addition, the individual can retain personal ownership of business assets.

  • Increased privacy — All the financial information of a sole proprietorship is privately held, unlike company financials published by Companies House.

  • Flexibility — You have complete control over how you run your business. Consequently, the venture can enjoy rapid growth without the restrictions that sometimes impede a limited corporation.

Disadvantages of Being a Sole Trader

Besides being directly responsible for business losses, liabilities, and obligations, additional disadvantages of operating as a sole trader include —

  • No legal distinction between you and your business — In case of mishaps, you are personally accountable for any harm suffered by individuals or entities interacting with your business. It’s imperative to exercise caution and consider the potential impact on yourself and how your actions may affect other parties involved in your business transactions.

  • It’s challenging to raise startup capital — Funders and banks will likely perceive your business as a one-man show with no formality regarding decision-making. Furthermore, the business structure makes it impossible for them to offer you money in exchange for equity or a stake in your company.

  • Funders and banks will likely perceive your business as a one-man show with no formality regarding decision-making. Furthermore, the business structure makes it impossible for them to offer you money in exchange for equity or a stake in your company. In a sole proprietorship, business profits are treated as personal income and subject to tax in the same financial year earned. Sole traders have few options for differing or reducing tax liability.

  • Personally liable for business debts — The trader bears direct responsibility for the business’s financial obligations. Personal assets, including savings and property, are exposed to potential risk if the business faces financial challenges and lacks the resources to meet its commitments, such as paying employees.

Warning

While some businesses have the luxury of just focusing on their interests, as a sole trader, you bear the added responsibility of protecting the interests of your counterparties. It is crucial to ensure that neither your business nor any transaction you have with them causes harm. In this role, you shoulder the responsibility, even if the other business fails to conduct its own due diligence.

How to Register as a Sole Trader Business In the UK

According to Gov.uk, you’ll need to enrol as a sole trader if —

“You earned more than £1,000 from self-employment between 6 April 2022 and 5 April 2023 or need to prove you’re self-employed, for example, to claim Tax-Free Childcare or if you want to make voluntary Class 2 National Insurance payments to help you qualify for benefits.”

One of the leading sole trader advantages is the ease of setting up. To register your business, follow these steps:

  • Name your business

    Once you determine that you fulfil the above requirements, consider whether you want to trade with your legal name or use a brand name. If you choose a business name, you’ll have to contextualise it as a trading name or T/A (Trading As). For instance, if your name is Connor James, and your trading name is TechHaven Ventures, then in official documents such as invoices and tax returns, you’ll label it as Connor James T/A TechHaven Ventures.

    Fast Fact

    Use a company name availability checker to ensure no other entity is using your preferred trading name. Further, before finalising your business name, thoroughly search the UK trademark register. Use specific keywords or phrases to ensure your preferred name is not already protected.

    Further, you are required to follow the naming rule applicable to the UK Ltd names, such as —

    • Do not include words such as ‘limited,’ ‘Ltd,’ ‘limited liability partnership,’ ‘LLP,’ ‘public limited company,’ or ‘PLC,’ which may mislead as to the structure of the business;

    • Avoid using offensive words, inappropriate or terms likely to cause harm or offence to any individual or group of people;

    • The preferred name must not suggest any illegal or criminal activity;

    • Do not use any sensitive words or expressions such as ‘chartered’ or

    • Your trading name should not imply any connection to the government or its agencies.

    There is no requirement to record your trading name formally, so it’s up for grabs for anyone who finds it. However, you can protect it by filing it as a trademark with the intellectual property office.

  • Register with HMRC

    Once you have the name, the next step is to sign up for self-assessment with Her Majesty Revenue and Customs through the Government Gateway. You’ll need a government gateway ID and password. After completing this process, you’ll get an individual unique taxpayer reference (UTR) number that will be used to identify you for taxation.

  • Register for VAT and National Insurance

    According to the law, mandatory VAT registration is necessary if your turnover surpasses £85,000 or you anticipate surpassing it in the next 30 days.

    However, recognising the numerous advantages of VAT registration, you may need to register voluntarily. Opting for voluntary VAT registration not only elevates the professional image of your business but also introduces flexibility to your tax planning, enabling you to reclaim VAT on goods and services.

    Please remember that you must sign up for national insurance before going in for self-assessment.

    Simplify Your Tax Compliance

    Register for Value Added Tax and maximise your profitability by reclaiming VAT on eligible business expenses.

Sole Trader vs. Limited Company

Understanding the difference between self-employment and a company is essential before you decide to operate your business as a sole trader. Keep in mind there are three main types of limited companies —

  • Limited Liability Company/Company Limited by Shares (LTD);

  • Company limited by guarantee (LBG); and

  • Limited Liability Partnership (LLP).

Myriad tax and legal differences set a sole trader apart from a limited liability company structure, as shown in the table below.

Sole Trader

Limited Liability Companies

Ownership and Management

The sole trader is the owner and manages the business.

Shareholder(s) own the business. It is managed by at least one director, who can also be a shareholder.

Legal status

There is no legal distinction between the business and the owner

The business is a separate legal entity distinct from its directors and shareholders.

Liability

Personal responsibility for business decisions and consequences. Therefore, in any adverse situation, the owner is sued in their capacity.

However, self-employed individuals can consider buying insurance to cover themselves from personal liability.

The company and not its owners are responsible for any harm done to other stakeholders.

The limited company director or senior manager may be held personally accountable for wrongdoing such as —

  • In situations where the director perpetrates fraud

  • Gross negligence manslaughter or homicide

  • Failure to remit sales and use tax or involvement in any tax avoidance scheme, even if a professional accountant provided such advice without the intent to cause avoidance.

A Limited Liability Partnership (LLP) provides tax reporting flexibility and protects you from the consequences of yours or your partner’s actions.

Insolvency

If the business fails, the owner is personally responsible for debts.

Should the business fail, liability is limited to the value of assets and paid or unpaid shares for LTDs.

Directors may be personally liable if they made a personal guarantee for the company’s borrowing or continued trading with an insolvent company.

For LBGs, liability is limited to the amount guaranteed.

In an LLP, liability is limited to the capital contribution of each partner.

Employment

Solo trader employment status is self-employed and is not considered an employee of the business.

Employment status is nuanced as follows —

  • According to off-payroll working rules, fees paid to a personal service company are treated as though the company owner is an employee of the client.

  • For an LLP, the employment status depends on classification. If classified as salaried partners, they’ll be considered employees; otherwise, the law treats them as self-employed.

  • In LTDs, the director is an office-holder and an agent of the company. However, they may be considered an employee if working with a contract of employment.

  • LBG guarantors are not employees, workers, or self-employed individuals.

Tax on profits

The self-employed trader is required to –

  • Pay income tax on profit through self assessment

  • Pay class 2 and class 4 National Insurance Contributions (NICs)

Tax obligations of limited liability companies include —

  • Subject to corporation tax on profits, which is lower than income tax.

  • Employees and some officers are subject to PAYE and NICs

  • Shareholders are subject to tax on dividends.

  • Off-payroll engagements are taxed under PAYE and NICs.

You can decide to leave profits in your business and extract them in another financial year.

Borrowing from the business and by the business

Whether or not you operate a separate business account, you can choose to borrow money from your business.

In case of overdrafts, tax relief on bank charges and interest is limited to the amount spent on business-related expenses.

A director loan (money that is not an expense repayment, salary, or dividend). Borrowing terms include —

  • Can borrow up to £10,000 without paying tax, but must be repaid within nine months.

  • If a loan is provided interest-free, the director pays a beneficial loan interest tax (tax on the interest that would have been due).

If a director lends money to the business with interest, the interest is treated as a business expense to the company and personal taxable income to the director.

The company must deduct income tax at 20% and report the same to HMRC using form CT61.

Extracting profits

A sole trader can extract profits from the business in the following ways:

  • Tax-free personal allowance — for the 2023/24 tax year, the personal allowance is £12,570.

  • Pension — You can pay 100% of your net profits or £60,000 a year (the 2023/4 Annual Allowance), whichever is the lower.

  • Pension carry forward annual allowance – If your profits/earnings fluctuate, you can carry forward unused pension allowance from the immediate three previous. years.

An LTD can extract profits in the following ways —

  • Salary – Both the director and the company have to pay NICs and tax if it surpasses the personal allowance limit, which is £12,570 per annum in the current tax year.

  • Pension — You can contribute 100% of your earnings (excluding dividends), which won’t be subject to capital gains or income tax.

  • Dividends — Shareholders can receive a tax-free dividend payout of £1,000 for 2023/24, after which the tax rate on company dividends is 8.75%, 33.5%, or 39.35% (basic, higher and additional tax rate).

If your business is an LLP, then you have the following options —

  • Drawings, fixed share profits, or salaries — Depending on the structure of an LLP, the members can either draw monthly profits with an annual top-up (for full equity partners) or receive a nominal percentage of profits – usually 0.5% + a monthly sum (for fixed share partners) or a salary with salaried partners who work with an employment contract.

  • Profit interests – A form of partnership interests that gives an individual right over future profits of the venture as an incentive to continue with their partnership. If appropriately structured, the interest may be tax-free.

Filing requirements

Sole traders must only report their income to HM Revenue & Customs as part of their self assessment returns.

Filing requirements for limited liability businesses are as follows —

  • Annual accounts, including a profit and loss account and balance sheet signed by a director, filed with Companies House

  • File a confirmation statement annually, confirming the company registered details, filed with Companies House

  • Corporation tax CT600 reporting income and allowable expenses filed with HMRC.

Further reading: What Is a Limited Company?

How to Change Your Business from a Sole Trader to Become a Limited Company

Transforming your business from a sole trader to an LTD marks a significant milestone in your entrepreneurial journey. Here is how to make the change —

  1. Set up a limited company — Company registration is an easy process. All you have to do is confirm the availability of your preferred company name. Next, provide a registered company address and appoint officials. As part of registration, Companies House will inform HMRC that a new company has been formed, and you’ll receive your unique taxpayer reference number (UTR) from them.

    Consequently, you must register your company for corporation tax within three months of business. Additionally, evaluate whether you want to enrol for VAT voluntarily or if mandatory registration is necessary due to an anticipated 12-month turnover exceeding £85,000.

  2. Inform HMRC that you’ve stopped being self-employed as a sole trader— You’ll do this by filing a last self assessment return before the deadline and telling them that you’ve stopped self-employment through your Government Gateway account.

  3. Transfer assets — You may need to transfer assets such as inventory, machinery, or property to the new business. Consider creating a director loan account through which the LTD will compensate you for the transferred assets over time if funds are limited. Work with your accountant to determine the most tax-efficient ways to transfer your assets, as you may be required to pay capital gains tax or may be eligible for reliefs such as incorporation relief, entrepreneur relief, or holdover relief.

  4. Open a business bank account – Banks require limited corporations to operate from a business bank account to help accurately track and report on business-related expenses.

  5. Notify stakeholders on the structure change — Inform your employees, suppliers, bank, or landlord to ensure that all paperwork and contracts recognise the change of details and legal status.

How to Form a Limited Company

Setting up a business as a limited company is easy and straightforward. The first step

  • Naming your business — Use our company name check guide to determine the availability and suitability of your preferred company name.

  • Choose and compare a registration package — We have four main packages as follows —

    • Digital Plan (£12.48): It includes the incorporating filing fee, digital incorporation certificate, digital articles of association, digital share certificates, digital company register, and a free accounting consultation. It also offers bank accounts with up to £55 cash back and a UTR number.

    • Digital & Print (£16.98): Includes everything in the Digital Plan, including printed certificate of incorporation and share certificates. It also provides bank accounts with up to £55 cash back and a UTR number.

    • Privacy (£27.48): The Privacy package includes a registered address and director address in London EC1, a free .co.uk domain name, a printed certificate of incorporation, printed share certificates, bank accounts with up to £155 cash back, and a UTR number. It also includes all the digital components from the Digital Plan, with an added £155 cash back.

    • Fully Inclusive (£54.48): Encompasses everything in the Privacy package and adds a trading address in London EC1, VAT registration, and a confirmation statement. It also includes bank accounts with up to £155 cash back and a UTR number. Like the previous plans, it provides digital incorporation elements, a free .co.uk domain name, and a free accounting consultation.

  • Submit your details — Once you determine the best package for your needs, fill out your company details, including the UK registered office, directors, and shareholders information, and leave us to take care of the rest. If you have any questions, please review our UK Company Formation Checklist

Article by

Fridar Gichuki

Fridar Gichuki is a lawyer by training turned dedicated content writer & strategist. She brings over 10 years of experience leveraging her legal acumen to support and inspire small businesses on legal, finance, and marketing topics. When not immersed in the world of content, you'll find her hiking across vast plains and scaling high mountains.

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