Sole Trader (or Sole Proprietorship) Explained

Last Updated: Jul 01, 2024
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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 business structure in which one individual runs and owns the entire business, is personally responsible for any losses the business incurs, and takes home all the after-tax profits.
  • Limited companies are subject to more extensive financial reporting obligations than sole traders, including filing annual accounts with Companies House. Some may prefer to run a business as a sole trader due to the simplicity of formation and the reduced burden of compliance requirements.

In this article, we explore 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?

Also known as a sole proprietor, you’re a ‘sole trader’ if you run your own business as an individual. Since the company is not legally distinct from the owner, you have unlimited liability, meaning you are personally liable. 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.

Related content: Limited Liability Partnerships (LLP)?

Advantages of Being a Sole Trader

As mentioned earlier, running your business 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 are not required to register your business with Companies House. However, you must inform HM Revenue and Customs that you are operating as a sole trader by enlisting for their online services. You will pay your taxes through a self-assessment tax return.

  • You keep all the profits the business makes — Since the company is yours and you operate under your name, you get to keep all profits after tax. 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 — As a sole trader, you’re self-employed, which means you have full control over your business operations. Consequently, the venture can enjoy rapid growth without the restrictions that sometimes impede a limited corporation.

Disadvantages of Sole Proprietorships

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

  • There is no legal distinction between you and your business — unlike limited companies, 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.

  • Raising startup capital is challenging — Funders and banks will likely perceive your business as a one-person show with no formal decision-making process. Furthermore, the business structure makes it impossible for them to offer you money in exchange for equity or a stake in your company.

  • Constraints in tax planning — In a sole proprietorship, business profits are treated as personal income and subject to tax in the same year earned. Sole traders have few options for differing or reducing tax liability.

  • Personally liable for business debts — The business owner 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 with them causes harm. In this role, you shoulder the responsibility, even if the other business fails to conduct its own due diligence.

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How to Register as a Sole Trader Business In the UK

To register your business entity, follow the relatively simple steps below —

  1. Choose a business name.

  2. Register as self employed with HMRC and fulfil your income tax and national insurance contribution obligations.

  3. Register for VAT if your taxable turnover surpasses £85,000 within 12 months or voluntarily.

  4. Obtain any necessary licenses or permits required for your business activities.

  5. Before you begin trading, open a business bank account to keep your personal and business finances separate.

  6. Keep detailed records of your business income and expenses for tax purposes.

  7. Consider registering for the Construction Industry Scheme (CIS) if you work in the construction industry.

  8. If you plan to employ staff, you must register as an employer with HMRC under the Pay As You Earn (PAYE) payroll scheme and comply with employment laws and regulations.

  9. Assess whether you need business insurance, such as public liability insurance or professional indemnity insurance, to protect your business and assets.

  10. Stay informed about any tax law or regulation changes affecting your business operations.

Naming Your Business

To name your business, consider whether you want to trade using your legal or brand name. If you choose a business name, you must contextualise it as a trading name or T/A (Trading As). For instance, if your name is Connor James, and your trading name is Boots and Sandals Ventures, then in official documents such as invoices and tax returns, you’ll label it as Connor James T/A Boots and Sandals Ventures.

Fast Fact

Use a company name check tool to ensure no other entity uses 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 formally register your trading, so it’s available to anyone who finds it. However, you can protect it by filing it as a trademark with the intellectual property office.

Related content: How to Register for Self Assessment Tax Return Using HMRC SA1 Form

Register for VAT

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, given the numerous advantages of VAT registration, you may opt to voluntarily register for VAT, which will not only elevate your business’s professional image but also introduce flexibility to your tax planning, enabling you to reclaim VAT on goods and services.

Simplify Your Tax Compliance!

Register for VAT and maximise profitability by reclaiming VAT on eligible business expenses.

How do I register as self-employed with HMRC for income tax and national insurance?

To register as a sole trader with HMRC for income tax and national insurance, follow these steps:

  • Determine if you need to register — If you’ve earned more than £1,000 from self-employment in the last tax year, you must register as a sole trader with HMRC.

  • Obtain a GOV.UK Government Gateway ID Sign up for a self-assessment tax return with HMRC through the Government Gateway. You’ll need to create a Government Gateway ID and password.

  • Complete the registration process — Once logged in, Follow the prompts to register for self-assessment. Provide the necessary information about your business activities and personal details.

  • Receive your UTR number — After completing the registration process, you’ll receive an individual taxpayer identification number from HMRC. This number is essential for taxation purposes and to identify you.

Following these steps, you’ll successfully register as self-employed for income tax, national insurance, and Class 2 national insurance contributions. You can calculate and pay income tax and national insurance by completing a self assessment tax return every year.

Insight

From April 2024 onwards, most sole traders will no longer need to pay Class 2 NICs. However, those with profits between £6,725 and £12,570 will be treated as having paid Class 2 NICs to maintain benefit entitlements.


Sole Trader vs. Limited Company

Understanding the difference between self-employment and a company is essential when deciding which type of business structure best suits you.

SoleTrader LTDs

Ownership and

The sole trader is the owner and

Shareholder(s) own the business. It is managed

Management

Manages the business.

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

The owner is personally responsible for business decisions and consequences.

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

The company, and not its owners, is 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 your 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.

  • In a company limited by guarantee, the 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 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 must 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 interest that gives an individual the right to 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

  • ile 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?

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 easy. 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 starting your business. Additionally, evaluate whether you want to register voluntarily or wait until your business reaches the VAT threshold for mandatory registration.

  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 liability 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 (£2.48): 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 (£6.98) 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 (£17.48): 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 (£44.48): Encompasses everything in the Privacy package and adds a trading address in London EC1, VAT registration, and a confirmation statement. It 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 — our 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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