Sole Trader

What is a Sole Trader?
VAT
Employing People
Business Plans & Cash Flow
Tax and NIC

What is a Sole Trader?

A sole trader is a business activity undertaken by a private individual. This could range from providing a service as an electrician to providing management consultancy. Setting up business as a sole trader is the quickest and easiest way of starting a business.

In essence you declare that you are a sole trader and start trading.

Obligation No. 1

You must inform Revenue and Customs within 3 months of becoming self-employed; as always with Government, there are penalties for failing to inform them.

It is a simple process, either go to the web site below or telephone your local tax office. www.hmrc.gov.uk/startingup

From the date you become self-employed you have to pay class 2 national insurance. This is a fixed amount regardless of the business profitability and it is usually paid weekly. See Tax Rates and Limits elsewhere in the ESA for current levels.

Because it is such an easy process, being a sole trader means that you as both a private person and a business person are viewed as one and the same for;

Tax and national insurance charges
Any debts you incur

This means that you are personally liable for all your debts both as a private person and a business person and all your assets (house, car, tools etc.) are potentially at risk.

Obligation No. 2

You will need to file a self-assessment income tax return each tax year. The income tax year runs from the 6th April to the 5th April following. It is probable that Revenue and Customs will send you a self assessment form automatically, If they do not, you still have an obligation to pay tax so you would need to let them know. For more information look at: www.hmrc.gov.uk/individuals/tmaself-assessment.shtml

As a sole trader, other than providing details of your trading activities in your self-assessment to Revenue and Customs, you do not have to tell anyone else about the financial performance of your business. That is unless you agree to, and this is commonly the situation with say your bank (especially if you borrow from them), your mortgage lender (to show you can repay the mortgage) and perhaps your accountant if they are to prepare your self-assessment and trading accounts.

VAT

If or when the turnover of your business (the value of your sales to your customers) exceeds a particular level, you may need to register for VAT purposes. The registration level varies from time to time (usually at the time of a budget) so see Tax Rates and Limits elsewhere in the ESA for current levels, or go to the Revenue and Customs site at www.hmrc.gov.uk/businesses/ and click on VAT.

Operating VAT should not be treated trivially and a full discussion with your professional advisor is strongly recommended. The operation of vat is in principle simple:

On sales to your customers you charge and collect VAT – known as OUTPUT TAX
You deduct the VAT you have been charged by your suppliers – known as INPUT TAX
You pay to or receive from HM Revenue and Customs the difference

Unfortunately the actual operation of VAT is more complex. Businesses are obliged to cope with multiple rates of VAT, exempt supplies, rules for trading with European Union as well as other imports and exports. VAT on certain types of business expenses cannot be recovered as input tax. The most common approach is to use the standard VAT scheme; however HM Revenue and Customs allow some special schemes i.e.

Cash Basis Scheme
Flat Rate Scheme
Annual Scheme

For the standard scheme VAT is accounted at the tax point date shown on invoices raised or received.

The Cash Accounting Scheme allows you to account for VAT on the basis of cash amounts actually received or paid out.

The Flat Rate scheme relieves that business of having to record the VAT on every individual sale and purchase transaction, but allows the VAT payable to be calculated as an agreed percentage of the VAT inclusive turnover. The business is still required to provide VAT invoices to all its customers.

Certain conditions must be fulfilled before you can use the Cash Accounting or Flat Rate schemes, please check with your Professional Advisor before making a decision.

VAT returns are required to be sent to HM Revenue and Customs periodically. The most common is quarterly, however in special circumstances monthly returns can be filed or a single annual return (Annual Scheme). Note that the Annual scheme does not mean you only make a VAT payment once a year, an agreed amount is paid quarterly and the final payment must reflect any correction to come to the amount shown on the annual return.

Again proper advice should be sought before moving to one of the schemes.

Employing People

As a sole trader you can employ people. You will need to inform Revenue and Customs that you are doing so. A helpful web site is www.hmrc.gov.uk/employers/first_steps.htm

Legislation with respect to the obligations and relationship between Employer and Employee has been growing considerably over the last years. An employee must have a signed contract of employment; proper care must be taken to ensure there is a safe and healthy place of work and that the employee is properly trained in working safely. It is good practice and commonly expected to have in place an induction program for a new employee as well as an appraisal process linked into development and training programs. A good place to get some advice in this area as well as other business support is the local Business Link office or the Business Link web site www.businesslink.gov.uk

Business Plans and Cash Flow

Just as with any business it is wise for a sole trader to ensure that there is a plan before starting trading, after all you are moving from employment with a regular income, to an income based upon when your customers pay you and having perhaps already paid amounts to your suppliers or incurred debts to them.

A business plan and a cash flow forecast are essential.

A business plan is a blue print for your business, and should layout how you will achieve your business goals. It is sometimes seen as something only to be written if seeking finance and whilst it is fundamental to that process it is also fundamental to keeping your business going in the direction you wish. It does not necessarily have to be a lengthy document, as long as it conveys what you are doing and how you are going about it. There is much help available in preparing business plans and a good place to start may be talking to your bank. But to help you think through the issues go to the Business Planning section of the ESA and perhaps use the downloadable tool.

A cash flow forecast deals with knowing when you will receive cash and when you will need to pay out cash and when you might need to find additional cash to keep going. IT IS VITAL; again your Accountant, professional advisor or bank can help, but you can look at our Cash Flow Forecast section of the EAS and even use the tool provided.

Tax and National Insurance for Sole Traders

Income from a sole trader’s business activity is subject to income tax. Just as when in employment, a personal allowance for tax-free income is available. In addition to the fixed class 2 national insurance, a further class 4 national insurance charge is applied as a percentage of the taxable profits.

Where the Sole Trader employs people, then the Sole Trader must operate PAYE (pay as you earn system); deducting at source the Income tax and national insurance its employees owe and paying them over to HM Revenue and Customs. Employee costs are deducted as business expenses and this includes the employer’s contribution to national insurance for all employees.

Taxable profits basically are calculated by deducting business expenses from the sales income. However the calculation details of particular sole traders taxable profits are unique and assistance from a professional advisor is recommended.