Setting up in Business as a Sole Trader
Introduction Many people who start their own business do so as a sole trader (sometimes referred to as a sole proprietor or sole operator). This is a simple business structure where the business is owned and operated by one person and there is no legal distinction between the owner and the business.
This factsheet explains the advantages and disadvantages of this type of business structure. It outlines the tax requirements for sole traders, covering registering for self-assessment, record keeping and liabilities for income tax and National Insurance. It also outlines the requirements regarding business names for sole traders.
Sole traders are treated by HM Revenue & Customs (HMRC) as self-employed for tax purposes and retain all their business profits after tax. However, they are personally liable for the debts of the business, which means that their home and other personal assets may be at risk if they are unable to pay the business' debts as they fall due.
The factsheet is intended as a starting point only. It is important to take professional legal and financial advice about the most suitable business structure.
Advantages of operating as a sole trader
It is relatively straightforward to start up or cease trading as a sole trader.
Sole traders don't need to have their business accounts audited or made public.
Sole traders have sole control of their business, allowing them to make business decisions quickly and easily.
All profits, after tax, belong to the business owner.
Disadvantages of operating as a sole trader
Sole traders are personally responsible for all debts and liabilities that their business incurs.
Sole traders often experience greater difficulty raising money for their business than limited companies. They generally start up using their own savings, loans secured against personal assets, or with money borrowed from friends and family.
Tax requirements for sole traders Overview Sole traders must register for self-assessment as a self-employed person with HMRC. They must complete an annual self-assessment tax return and pay income tax and Class 2 (and in some cases also Class 4) National Insurance contributions (NICs). If it appears that their turnover will be more than the mandatory VAT registration threshold in any 12-month period, they must also register for VAT. The VAT registration threshold is announced in the Chancellor's Budget and usually changes every April. They must also keep records of their business income and expenditure, and their personal income.
Registering for self-assessment Sole traders need to register with HMRC for self-assessment when they start trading. At the latest, they must register by 5 October after the end of the tax year for which a tax return is needed (that is, the tax year during which they started to trade).
Sole traders can make a single registration for both tax self-assessment and National Insurance contributions via HMRC's online services. The registration process varies depending on whether the business owner has completed a self-assessment tax return before, for example if they have been self-employed previously or been registered for self-assessment as an individual with investment income.
Income tax All profits made by a sole trader are potentially taxable, including money that has been taken out for personal use in the form of 'drawings' and any money that remains (for example as cash in the bank) at the end of the tax year.
However, tax is only charged on 'taxable' profits, which is the amount of profit that remains after deduction of allowable business expenses and capital allowances on equipment. In addition, sole traders are entitled to the same tax-free personal allowances in relation to income tax as people who are paid under PAYE (Pay As You Earn), and so for the tax year 2023/24 the first £12,570 of a sole trader's taxable profit is free of tax.
Once the tax due on the taxable profits has been calculated and paid, sole traders retain the remainder of the profits, which they can choose to draw out (as personal income) or re-invest for business purposes.
Sole traders must complete a self-assessment tax return each year, giving details of all sources of income, tax allowances, relief or gains. They can file self-assessment tax returns online or by post. Under self-assessment, income tax payments are usually due twice a year in January and July. However, sole traders can choose to make regular weekly or monthly payments in advance.
National Insurance contributions Sole traders must pay Class 2 National Insurance contributions (NICs) if the following circumstances apply:
They are over 16 years of age, but under the state retirement age.
Their profits exceed the small profits threshold (£6,725 for 2023/24).
Class 2 NICs count towards an individual's state pension and certain other benefits. For this reason, sole traders may choose to pay Class 2 NICs even if their profits fall below the small profits threshold.
Sole traders with profits above the lower profits limit (£11,908 for 2023/24) must also pay Class 4 NICs, which are charged at a percentage of a sole trader's profits, based on the information provided in their self-assessment tax return.
Class 2 and Class 4 NICs must be paid at the same time as income tax.
VAT
Business owners whose turnover is above the mandatory VAT registration threshold (£85,000 in 2023/24) in any 12-month period must register for VAT. Sole traders whose turnover is below the VAT threshold may choose to register voluntarily.
Record keeping
Sole traders need accurate financial records to help them complete their tax returns. They also have a legal obligation to keep these records for a specified time, in case HMRC asks to inspect them.
Sole traders must keep:
Records of all business income and expenses, and personal income. (These must be kept for at least five years after the 31 January submission deadline for the tax year they relate to.)
All VAT records, if the business is registered for VAT. (These must be kept for at least 6 years.)
Any PAYE records, if the business employs staff. (These must be kept for at least 3 years after the end of the tax year they relate to.)
Business names Sole traders can trade under their own name or choose a different name for their business. If a sole trader chooses to trade under a name that does not include their surname, they must ensure their business stationery displays both their name and the trading name of the business - for example, "Peter Simpson, trading as Quicksilver Plumbing". There are some restrictions on the words a business name can include.
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