TAX BASICS

Who is a sole trader? How to pay sole trader tax?

A sole trader is the simplest type of business structure defined in UK law. It refers to an individual who owns their own business and retains all the profits from it. There is no legal distinction between the owner and the entity. Therefore, you are personally responsible for the business bills, keeping accurate records of your business, and you are personally liable for any losses. We will now dive into the structure, advantages, disadvantages, and tax responsibilities of a sole trader.

What are the advantages?

Fast and easy to set up

There is no need to register with the companies house. To commence your activities as a sole trader you only need to inform the HMRC that you self employed.

Faster Decision Making

There are no other shareholders in the business to consult and this allows the sole trader to make faster decisions.

Freedom of operation

Since no one else is involved in the business. It allows the sole trader to operate the business at their comfort. There is no obligation and allows one to execute their strategy.

Allows to make dynamic changes

The market is a dynamic environment and every business needs to adapt to those changes. A sole trader can make these changes as and when needed. Moreover, this structure offers much needed felxibility in the operations of the business.

A sole trader has fewer legal obligations

A limited company director needs to submit annual accounts and a corporation tax return to the companies house. Whereas, a sole trader do not need to submit any such reports. However, they must submit a self assessment tax return.

Privacy

As discussed a limited company needs to submit its annual accounts to the companies house. However, this information is publicly accessible to anyone. Meanwhile, a sole trader is not required to submit the annual returns and hence no such information is available to the public.

Lower cost

It is much easier to set up as a sole trader, unlike a limited company. This also means that the cost of setting up is significantly low. To register as a limited company the director of the company has to employ professional help. A sole trader can avoid all such setting up costs. Another key cost reduction is in the operational costs. A sole trader needs to maintain accounts, however, the required tax filings are less and will save a decent amount.

Tax Responsibilities of a Sole Trader

  • To keep a record of all revenue and expenses.
  • To file a self-assessment tax return every year.
  • Pay income tax according to your tax band.
  • If your annual profits are £6,475 or more for the year, then you have to pay a Class 2 National Insurance Contribution. The rate is fixed at £3.05 per week for the tax year 2020/21.
  • If your annual profits are £9,501 or more for the year, then you have to pay a Class 4 National Insurance Contribution. For profits between £9,501 to £50,000, the rate is 9% and for anything above £50,000 it is 2%.
  • Register for VAT if your turnover is more than £85,000.
  • You are also required to hold records digitally if you are VAT registered due to HMRC’s Making Tax Digital (MTD) introduction.

How to register as a sole trader?

  • You need to inform HMRC that you are self-employed. You can do this by going to the gov.uk site. The entire process is very simple and convenient. You can also call HMRC call center at 0300 200 3500 and they will help you with the procedures to set up.
  • You need to register for the self-assessment in order to pay your tax.
  • Name your business. You can choose an appropriate name that matches the criteria of the HMRC and you are done.

Should I register myself as a sole trader?

It depends on your personal preference, but whichever you choose would decide how you pay your taxes to HMRC. If you are a sole trader, you pay your tax to HMRC by a self-assessment. On the other hand, if you form a limited company. You will have a company that your clients will pay and, your company will pay you by way of salary and dividends. As a sole trader, you depend on your own credit rating to borrow money. A limited company can establish its own credit rating, which can support borrowing to invest in the business. 

These are some of the factors which differentiates a sole trader structure. However if you do not have an answer to your query, please feel free to write to us.

Sidharth Bharthan Menon
CEO, taxtotal​