Starting a business in the UK
If you are looking to start your own business in the UK, you may be a little overwhelmed when it comes to your options. How do you start a business? What kind of business can you start? What are the legalities of starting a business in the UK? There are lots of options out there, but in this article we will concern ourselves simply with becoming a sole trader. But what is a sole trader?
Becoming a sole trader is one of the most popular ways to start a business in the UK. It’s the option that is most attractive to freelancers because you only need one person to run it, hence ‘sole’ trader. That doesn’t mean you can’t have people working for you, but more on that soon.
As a sole trader you are self-employed, and you are responsible for running the business. This means you are responsible for things like the profits and losses of the business, and for the taxes that need to be paid. You must keep records of your income and expenses and complete an annual Self Assessment. You don’t need to register with Companies House to become a sole trader, and you won’t need to team up with directors or partners, or involve any outside investment.
- Sole trader example
- Responsibilities of a sole trader
- Paying tax as a sole trader
- National Insurance
- Advantages and disadvantages of being a sole trader
Sole trader example
I am registered as a sole trader, as I earn money from freelance writing. If you are a freelancer in the UK, you will most likely want to become a sole trader too. Other people who might opt to become a sole trader include prospective small business owners, such as those with online ecommerce shops, or small brick and mortar businesses.
Plumbers and electricians may register as sole traders, along with builders and taxi drivers. If you are ever unsure about which type of business is right for you, I recommend checking out the Gov.uk website. There, you will find lots of useful information about how to become a sole trader, and how to start other kinds of businesses too.
When do you need to register as self-employed?
Whether or not you want to become a sole trader, there are certain circumstances that might require you to register as self-employed anyway. The most important reason is if you earned more than £1000 from self-employment in the most recent tax year. We will talk more about taxes in a later section, but the tax year in the UK runs from the 6th of April to the 5th of April in the following year.
You may also want to register as a sole trader if you need to prove that you are self-employed for certain benefits, such as Tax-Free Childcare. There are also some benefits that require contributions of Class 2 National Insurance, and you can do this voluntarily when you register as self-employed.
Responsibilities of a sole trader
I said in the beginning that as a sole trader you are responsible for the profits, losses and taxes of your business. To manage this you need to have a way of keeping records of things that you buy for the business and any money that the business makes.
Without going into too much detail about the financial specifics of being a sole trader, this basically means you need to keep your receipts for business related purchases – new equipment, stationary, property etc – and ensure you have a proper invoicing system for clients. You could hire an accountant, or you can do things yourself. There are also lots of digital accounting solutions you can use which simplify the process for small businesses, such as FreshBooks and QuickBooks.
You need to keep records of any money that comes in and any money that goes out (for the business that is, you don’t need to log every cup of coffee you buy!). This allows you to balance things up at the end of the tax year and then pay the right amount of tax.
While you will be able to take home the profits as a sole trader, you will also be responsible for paying any debts you owe. Unlike other forms of businesses, if the business stops making money and instead starts costing money, you are responsible for ensuring anyone that is owed money receives it. This could be creditors, or simply bills you need to pay in order to run the business.
You should also note that, although you are responsible for all of these things, you can still hire staff to work for you. In this case, you will be responsible for the hiring process. From making sure they can legally work in the UK to giving them the proper paperwork and registering them for the PAYE framework, you will take care of everything. Then you need to ensure that the right tax comes off of their wage each week or month. Thus, you can end up with yet more tax responsibilities on your hands if you want to hire employees.
Let’s go through the basics of paying tax as a sole trader without any employees, to keep it simple. As always, I recommend checking out the Gov.UK website for more information about taxes in general.
Paying tax as a sole trader
Perhaps the most important responsibility you will have as a sole trader is keeping on top of the tax you owe. When you first start out, you probably won’t have much to pay, unless you have a lot of success and many clients or customers in your first year. You may not even have to pay any tax, but you will still need to fill out a Self Assessment tax return. This was the case for me in my first year of freelancing.
I go into more depth about paying tax as a sole trader in this article, and I give plenty of examples of things like Income Tax and National Insurance. I recommend checking this out if you are not familiar with paying tax, or simply want to see some examples that will (hopefully) make it a little easier to understand.
What you need to know
All you really need to know for paying tax as a sole trader is:
- How much money your business brought in – your revenue
- How much money you spent on the business – your expenses
The total amount of money brought in by your business is called your revenue. You must subtract your expenses from your revenue to get your profits. The Gov website has a list of valid business expenses here. Seeking advice from an accountant (if you can) is always a good idea if you are unsure if something you buy qualifies as an expense.
What you are left with is your profit, and this is what you pay tax on. You need to have profits above a certain threshold, known as the tax-free Personal Allowance, in order to pay any tax. For the 2020/2021 tax year this amount is £12,500. There are then various tax brackets that you can fall into depending on how far above this your profits are, and once again you can find out more about this by checking out the Gov.UK website or my article on paying tax as a sole trader.
Once you have all of your records for revenue and expenses in order, you can then fill out your Self Assessment tax return. When you do this online you simply fill out the form as it tells you to with the necessary figures. The document will then automatically calculate any tax that you owe and present it to you at the end, along with any national insurance you owe.
Paying National Insurance
National insurance is calculated in a slightly different way to income tax, and you can see the relevant rates here. I give some examples of paying National Insurance in the article linked to previously, but I really recommend getting familiar with these rates in any way you can. This is so that you don’t get any nasty surprises when it comes to paying your taxes!
Once you complete your Self Assessment form, you will have the figures you owe in income tax and National Insurance contributions. You will need to have completed this Self Assessment by midnight on the 31st of October of that year if you are filling out a paper return, or by midnight on the 31st of January of the following year if you are filling out an online return. You will then need to pay the tax that you owe by midnight on the 31st of July.
For example, for the tax year running from the 6th of April 2020 to the 5th of April 2021, you will need to have submitted your paper tax return by midnight on the 31st of October 2020, or your online form by midnight on the 31st of January 2021. You will then need to pay any tax that you owe by midnight on the 31st of July 2021.
Payments on Account
However, you may need to use a system called payments on account if you are a sole trader. This is essentially two payments, with one made by the January deadline, and one made by the July deadline. It is quite a confusing system if you have never come across it before, so I will upload a separate article all about it soon. You don’t need to worry about this if you owe less than £1,000 in tax after any relevant deductions such as from PAYE, or if 80% of the tax you owe is deducted at source, again through something like PAYE.
Paying tax as a sole trader can be a little confusing at first, but really it is a case of filling out the form using the financial records that you have kept for yourself, and letting the form do the work. You can fill out a paper form instead, but I recommend filling it out online. It will also just make things much easier!
So, we have covered the basics of what a sole trader is and some of the information regarding paying taxes. Let’s summarise the good things and the bad things about being a sole trader, so you can decide if it’s the right move for you.
Advantages and disadvantages of being a sole trader
There are positives and negatives to everything, and being a sole trader is no exception. While you can enjoy the freedom of being your own boss, you have a lot of responsibilities. While you take home all the profits, you also must deal with all the losses. It may be easy to set up as a sole trader, but you might find it difficult to secure financial backing from banks and investors in the future. Registering as a sole trader is the ideal choice for lone wolves looking to enter the world of business. However, when things really take off you may need to revaluate and think about different business types.
Sole trader advantages
- You can be your own boss!
- It’s easy to set up as a sole trader
- You don’t need any directors, partners or investors
- You can keep all the profits!
Sole trader disadvantages
- You are responsible for both profits and losses
- You need to keep financial records and fill out tax returns
- It can be hard to secure clients and external funding as a sole trader
So, whether you are a freelancer like myself, or an entrepreneur with a small business idea you are desperate to test out, becoming a sole trader could be the right choice for you. Hopefully this article has helped you make a decision, but feel free to check out the other articles on the blog for more information about starting a business in the UK.
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