Setting up as a sole trader

Being a sole trader is the simplest way to get started in business. Once you have informed the government agencies of your intentions to go self-employed, you can start trading right away (subject to any specific licences you might require in your line of work).

As a sole trader, you can quickly adapt to changes in your business with minimal bureaucratic changes required and you have complete control over your business and accounting affairs. However, a sole trader is also ultimately responsible for any liabilities should anything go wrong. It is worth spending time considering which set-up company format is best for you.

Setting Up

As a sole trader, you will not need to notify Companies House, nor deal with any administrative or accounting requirements which are required of limited companies.

If you start working for yourself, you must register with HMRC as self-employed, even if you already send in a tax return. There are some exceptions and special rules for particular industries, like the construction industry.

If you’re not sure whether you need to register as self-employed, read the leaflet entitled: IR56 - employed or self-employed (PDF Format).

If you’re thinking about becoming self-employed, call the HMRC Helpline for the newly self-employed on 08459 15 45 15, and read the official HMRC advice pages here.

You should register the moment you start out as a sole trader, otherwise you could incur a financial penalty.

To register, you need to fill out and complete Form CWF1 from the HMRC site (PDF format).

Tax & National Insurance

Essentially, your business income is counted alongside your existing personal income, so the accounting side of your business will be very straightforward. As the name suggests, you will be personally liable for any debts you incur in the running of your business which you wouldn’t be under the limited company route.

In terms of accounting, you will need to submit an annual self assessment form to HMRC and keep accurate and up-to-date records of all business transactions and accounts. You will also pay income tax on all profits and pay national insurance contributions on those profits. Losses can be offset against tax on other income.

In the April after your business starts, HMRC will send you a self assessment tax return to fill in. HMRC will also use the return to assess any profit-related (Class 4) NI contributions you may need to pay.

Self employed people are also liable for Class 2 NI contributions (currently £2.40 per week: 2009/10 Tax Year).

If your income from self employment is low, you may be able to apply for the Small Earnings Exception.

Also, if you’re already paying NI contributions in another job, you may be able to defer paying your Class 2 contributions until the end of the tax year. There is a dedicated Class 2 NICs Helpline on 0845 915 4655 where more advice is available.

For more on sole trader taxation, try our popular Sole Trader Tax Guide.

For general taxation guides, which cover everything from income tax rates to self assessment, click here.

Value Added Tax (VAT)

Even though you will have registered as 'self employed' when setting up, you won't automatically be VAT registered. You don’t usually need to register for VAT until your turnover reaches a certain limit in any 12 months, or you expect it to do so. This limit – the ‘VAT threshold’ – is currently £68,000 (from 1/5/2009 - previously it was £67,000).

The standard rate of VAT has been reduced from 17.5% to 15% from 1st December 2008 until 31st December 2009 following the 2008 Pre-Budget Report.

Your annual turnover is normally the total amount of money coming into your business from the goods or services you sell. You can read our VAT Guides for more details.

Insurance and Banking

Once you've decided to become a sole trader, and have informed the authorities, you should think about taking out the appropriate business insurance cover for your new venture. You may need to take out public liability and employers liability cover as well as insurances specific to your trade or industry.

You will probably also want to open a business bank account. As a sole trader, you can open an account such as "John Smith Trading As BLT Construction", which will enable you to keep a separate account to your personal one. The choice is up to you.

Other Considerations

Being a sole trader will suit a large number of small business people, however it is not always the best route which is why we suggest discussing your choices with an accountant or other adviser.

The limited company route limits the personal liability of its directors if something goes wrong, whereas the sole trader is ultimately personally liable for any losses the business makes, of if you are forced into bankruptcy. Also, in some areas of business, having a limited company will enhance prestige and provide a more professional appearance in certain industries.

Of course, you can always start out as a sole trader, and then incorporate at a later date, if you choose to. A professional adviser (such as an accountant) can help with this transition.

Sole Trader Package

Our partner, Duport, has launched a new Sole Trader Package which will help you get up and running as a sole trader in a matter of hours (including the forms you need to register with HMRC). The package will also protect your company name in case you want to use a limited company at some time in the future. You can find out more here.