 Being a sole trader means the only one person owns the business and either works alone or employs others. Being a sole trader is the easiest way to start a business.
The main advantages of being a sole trader are that there are very few legalities to overcome before the business can be established, all profits are classed as personal income and the accounts of a sole trader are not liable for auditing.
The main disadvantage of being a sole trader is that there is unlimited liability, meaning that the sole trader is liable for all debts. There is the further disadvantage that all income is taxed whether it is taken out of the business or not.
Setting up as a self-employed sole trader is a simple and popular way to start a one-person business. There is very little paperwork to be maintained and few fees to pay. Accounting and record keeping is relatively straightforward and there is the added benefit of being your own boss.
The first step to becoming a sole trader is to choose a business name. You can trade under your own name or come up with a suitable business name. If you do decide to use a business name, you must ensure that all your business stationery and corporate communications displays the trading name of the business along with your own name.
You should check that your trading name is not the same or too similar to that of another business that already exists to avoid confusion and legal problems.
As a sole trader, you have to pay income tax on any profits that your business makes. You must fill in a self-assessment tax return each year, detailing your income and expenses. You should also make sure that you are registered as self-employed with HM Revenue & Customs as soon as you start up in business on your own. Failing to do this within the first three full months of becoming self-employed can result in you having to pay a penalty of £100.
You can download form CW1 to register as being self-employed from the HM Revenue & Customs website by clicking here
Since you are self-employed, your profits are taxed as income. You need to pay fixed-rate Class 2 National Insurance contributions (NICs). Setting up a monthly direct debit is a good way to ensure you pay in time. If your annual profits are over a certain amount (£4,895 in 2005/06) you will have to pay Class 4 NICs. You pay these along with your income tax – the amount you have to pay is calculated from your self-assessment tax return.
It is important to note that as a Sole Trader, you have to pay tax whether or not Cash is extracted from the business. This disadvantage can be overcome by incorporation since corporation tax rates are much lower than income tax rates and you only pay income tax on cash extracted. Hence, by incorporation you can save tax by leaving cash in the company if you don't need it for living costs. However, this does increase the amount of paperwork involved.
If your business has or is expected to have a turnover of more than £60,000 a year, you need to register for a VAT number and must charge your customers VAT. You also need to complete the relevant VAT returns and send VAT payments to HM Revenue & Customs. For a more detailed on VAT regulations, click here
Contrary to perception, Sole traders can take on employees just like any other business. If you do have employees, you will need to collect income tax and NICs from them and pay these to HM Revenue & Customs. You will therefore need to operate a Pay As You Earn (PAYE) payroll system.
You must remember to keep all the financial records you will need to fill in your tax returns. It's a good idea to store all your receipts and transaction records in a safe place and in date order. The more organised you are with your paperwork from day one, the easier it will be for your accountant or you to compile your tax return at the year end.
It is important to note that as a sole trader, you are personally and solely responsible for any debts run up by your business. This means your home or other assets may be at risk if your business runs into trouble.
If operating as a sole trader, profits (or losses) will be taxed under Income Tax rules and you can continue working in employment under PAYE (Pay As You Earn).
You have three months from the date of commencement to notify your Tax District that you have started a business. At the end of the tax year in which you commenced trading in your own business you must complete a Tax Return including a Self Employment section. Basically if your turnover is under £15,000 you only need to fill in figures for turnover, expenses and profits. If the turnover is greater than £15,000 detailed profit and loss and balance sheet figures are required. Profits for the period up to the 5th April after you started will be subject to tax. Self employed payments of Tax and National Insurance are required twice yearly - by 31 January and 31 July.
You need to keep a record of income and expenses and a set of accounts (a profit and loss account and balance sheet) will be required. If you buy equipment you are allowed a proportion of the cost (called capital allowances) as a deduction from your profits for tax purposes.
If you are working from home a proportion of the household expenses might be allowable. There may be others who should be advised that you have started a business from home such as the local authority, your insurance company, etc. If your business annual turnover reaches £60,000 you must register for VAT.
Although anyone can set up in business as a sole trader, for certain types of work you may need a licence or permission from your local authority. Restaurants, child minders, cab drivers and street traders, for example, all need to have a local authority licence. In addition, your qualifications and business premises may be inspected beforehand to ensure you comply with certain regulations.
Special tax rules apply to subcontractors in the construction industry. You can find out about tax for construction industry subcontractors on the HM Revenue & Customs website.
You can check whether you're properly set up as a self-employed sole trader by answering these quick questions.
Have you:
- Registered as self-employed with HM Revenue & Customs?
- Obtained any permits and planning permission that you may need from your local authority?
- Found out from your local authority whether you need to pay business rates?
- Contacted HM Revenue & Customs to register for VAT if you expect to have a turnover of more than £60,000 a year?
- Set up a financial record-keeping system?
- Made sure that your own name is on all your business stationery, including letters, invoices, receipts and cheques?
To find out more about , please call us at +44 (0)1223 507080 or email at info@tax.uk.com
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