In the UK, there are four different ways you can set up your business for tax purposes. They are Sole trader, Partnership, Limited Liability Partnership (LLP) and Limited company.

In the first of a four part series, we’re looking at sole trader status and offering an outline so you can decide whether it’s right for you and your business.

Sole trader

Being a sole trader is the simplest business structure available.  It’s for businesses where one individual is running the business. If your business consists of you and the tools of your trade, then this may be a suitable business structure for you.

The advantages of being a sole trader are:

• The business is simple to set up and simple to run;
• There aren’t as much paperwork or regulations as there are for limited companies;
• You don’t have to put your address on any of your business documents except the invoices you issue to your customers, which helps keep your details private, especially if you’re working from home; and,
• When your accountant works out your business’s tax, if your business makes a loss in its first few years of trading you can set those losses off against your other income in current or previous years. This means that if you paid PAYE in the preceding three years, you may get this refunded by HM Revenue & Customs, which will help with your cashflow.

But there are disadvantages to being a sole trader:

• There is no legal difference between you and your business. So if the business is sued, you’re sued – which means, in the worst-case scenario, that you could be at risk of losing your home, your car, and other personal belongings; and,
• If your profits exceed a certain level, you could pay more tax as a sole trader than you would if you traded through a limited company

Who must I tell that I’m a sole trader?

You must tell HM Revenue & Customs that you’re in business and you do so by submitting form CWF1 (www.hmrc.gov.uk/forms/cwf1.pdf). You have to do this within 3 months of starting your business or you could receive a £100 fine. Unfortunately you can’t register in advance of starting your business.

HM Revenue & Customs then require you to fill in a self-assessment tax return every year.

And that’s it. You don’t have to tell any other official agencies. For example, you don’t have to tell the VAT man – unless you decide your business should be registered for VAT.

What taxes do I pay as a sole trader?

You’ll pay income tax and class 4 National Insurance on the profits your business makes.

It’s similar to having income tax and National Insurance deducted from your salary when you’re an employee. However, when you’re a sole trader you only pay tax and NI twice a year.

Unless your business is very small (its profits are under £5,595 in the 2012/13 tax year ), you’ll also have to pay class 2 National Insurance, which is charged at a flat rate per week and doesn’t vary with the amount of profit your business makes. In the 2012/13 tax year the rate is £2.65 a week and this is usually paid by direct debit, on a six-monthly basis.

What we can do for you

If you’re looking at starting a business, we can advise you on whether starting out as a sole trader is appropriate for you.

If being a sole trader is right for you, then we’ll register you as self-employed with HM Revenue & Customs within the required time limits.

Every year when we prepare your accounts and Tax Return, we’ll review your position to see whether being a sole trader is still the most tax efficient way for you to trade. If there are any tax savings in another trading style we will quantify them for you and advise you of the pros and cons of that trading style.

If you’re starting up in business, contact us today to make sure you select the right trading vehicle for you.

Remember, as members of the ICAEW Business Advice Scheme we offer free initial consultations to new businesses.