Setting up as a sole trader can be simple and inexpensive, but with it comes a lot of responsibility. For example, in law you are personally liable for any business debts you incur. You must have a legally acceptable business name and you must register your business with HMRC so you can pay any tax or National Insurance contributions due.
You also have a responsibility to operate your business in accordance with the law and you should take out insurance to ensure you can meet any claims for problems caused by your business.
This article sets out the main areas of responsibility you have as a sole trader. If you are unsure of any requirements, it’s important to take professional advice.
As a sole trader, there is no difference between your personal assets and those of your business. You have unlimited liability, which means that if your business incurs any losses, your creditors can take your personal property or possessions to recover debts. So if your business doesn't go well you could get into hot water. That makes it essential to understand and comply with your legal obligations to your clients, suppliers and HMRC.
You may choose to trade using your own name, or you may prefer to choose another name for your business. Although you don’t have to register your business name, you must include it, together with your business address on official documents such as invoice, purchase orders, tax returns or business correspondence.
Although there are no rules on the type of name you choose, you cannot use terms like ‘limited’, ‘Ltd’, ‘public limited company’ or ‘plc’ as they give the impression you have a different legal status.
As a sole trader, you are normally considered self-employed by HMRC for tax purposes and you would pay tax through the self-assessment process. However, HMRC does not regard all sole traders as self-employed, so you must prove your status.
The essential test is that you work for more than one client. If you are just starting a business and have no clients, you must make it clear that you plan to work for more than one. You must run your own business with responsibility for its success or failure, provide your own equipment for carrying out the work, bid for work and submit invoices, and are free to work for more than one client.
To help you check your status, HMRC provides an Employment Status Indicator on their website. The tool asks a series of questions about your contract with a client, your role and responsibilities, how you are paid and any benefits you receive. Based on your answers, HMRC will then decide your status for tax purposes.
If your business as a self-employed sole trader is likely to earn more than £1,000 per year, you must register with HMRC so that you make annual tax returns and pay any Income Tax or National Insurance contributions due. Below that figure, any earnings would be treated as ‘hobby income’. Although it might still be liable to tax depending on any other income you might have.
It’s essential to register with HMRC as soon as possible after you begin trading. However, there are guidelines on when to register.
If you became self-employed before 5th April 2022, you should have registered by 5th October 2022. If you haven’t already registered, you may be liable to a penalty.
If you become self-employed after 5th April 2022, you must register by 5th October 2023 at the latest, although you can register anytime before that date.
Once you’ve registered, HMRC will create an account and send you a letter with your Unique Taxpayer Reference (UTR) number. You’ll then receive another letter with an activation code for your account. When you’ve activated your account, you can file your tax return any time before the deadline, which is 31st January each year for filing online.
Traditionally, you choose a date for your accounts that coincides with the start of your business. Your accounts would then cover 12 months from that date. So, if you set up on 1st January, your accounts would cover the period 1st January to 31st December. This is known as the ‘basis period’ for calculating your annual profits, which are then liable to tax.
However, in the tax year 2024/25, the basis period for taxation will change. Currently businesses are taxed on the profits incurred during their accounting year, which may not coincide with the tax year 1st April to 31st March. HMRC will remove that basis period and businesses will be taxed on profits incurred during the tax year.
Although there will be a transition period to adjust your accounts, it may be worth making the change earlier. A small business accountant can advise on the most suitable way to make the change.
You must keep accurate records of your business income and expenditure so that you can calculate your profits for Income Tax.
As well as giving you an indication of the financial health of your business, the records could prove useful if you find errors in HMRC’s calculations or if you have to submit evidence if HMRC decides to investigate your tax affairs.
You must keep your records for at least 5 years after submission on 31st January. For example, if you submitted your 2020 to 2021 tax return online by 31st January 2022, you must keep your records until at least the end of January 2027.
Once your business is running, you will have to file an annual self-assessment tax return. You can either complete a paper return or file online. If you file a paper return, you must submit the form to HMRC by 31st October. The latest online filing date is 31st January.
As you complete the self-assessment form, you must answer all the relevant questions accurately, providing information on your business, your income and expenditure relating to the business and any income from other sources, such as interest, benefits or capital gains.
Using the income and expenditure information you provide, HMRC will calculate your profit from the business and tell you the amount of Income Tax and National Insurance contributions you have to pay.
If you agree with HMRC’s calculations, you must pay the due amount, which is normally in two instalments – 31st January and 31st July. You must pay by the correct date or HMRC may charge interest and penalties on any overdue amount.
If you are unable to pay by the due date, you must contact HMRC and explain your circumstances. You may be able to arrange a ‘Time to Pay’ agreement.
You must register for VAT if your turnover is over £85,000. You can register voluntarily if it suits your business, for example if you sell to other VAT-registered businesses and want to reclaim the VAT.
Related: VAT in the food industry
Although there is no legal obligation, it’s important to take out insurances such as public liability, product liability and professional liability policies to protect your business against the risk of legal action. Remember, you are personally liable for any claims, so insurance could prove essential.
If you run your business from home, you may have to obtain certain permissions. For example, you may need permission from your mortgage provider or landlord, or local council if your home requires alterations or you have large numbers of deliveries. You may also have to pay business rates on the part of your property that you use for your business.
You may need to change your home insurance policy as it may not cover your business equipment or any business visitors to your home.
Although you start your business as a sole trader, you may find there are limitations as your business grows. For example, you may want to access finance for growth, you may want to increase your personal earnings or you may want to reduce personal financial risk.
If you do, you can consider changing from a sole trader to a limited company and also benefit from the tax advantages. Incorporating your business and setting up a limited company will allow you to take advantage of the latest rate of Corporation Tax – currently 17 percent on profits. This compares favourably with paying the marginal rate of Income Tax on profits and you can also claim a wider range of allowable expenditure.
Making the right decision about your business as a sole trader can be complicated and time-consuming. Our team of small business accountants and lawyers are highly-experienced in helping sole traders and self-employed people with professional advice, as well as practical help with accounts or tax returns.