What Are The Legal Obligations Of A Sole Trader?

What Are The Legal Obligations Of A Sole Trader?

So, you want to start your own business?

Exciting times: you’ve decided that you want to work for yourself! The reasons are many: You want to work on what you like and what you’re good at.

You want the freedom to work wherever and whenever you choose to and to control every aspect of your business. And you wish to choose your own customers.

Running your own business does, indeed, carry a number of benefits. However, it also carries risks and responsibilities. Yes, you will work for yourself and take all decisions. However, that means there’s no one to stop you if you make a wrong choice. And yes, you will be the sole beneficiary of your successes. But you’ll also be personally liable for any debts you might incur.

To ensure your company’s success, you need to be aware of seemingly mundane issues like your legal or tax responsibilities. And the very first decision you’ll have to make, before you even start, concerns your ideal company formation.

This can be anything, from sole trader to LTD, PLC, LLP, Unlimited… the list goes on. So, how do you choose the one that’s right for you?

Benefits of a sole trader

There are several business structures which let you work for yourself, for example by becoming a partner in a business partnership or setting up a limited company.

However, the simplest way is to become a sole trader. Straightforward yet powerful, being a sole trader carries a lot of benefits:

  • Sole trading offers a simple business model with few accounting requirements, low costs, and relatively little paperwork.
  • You are not limited to the kind of service you can provide. Indeed, you can sell products, services, or both if you so choose.
  • Just like with larger business structures, you can hire people to work for you.
  • You can buy any machinery or equipment necessary for your work and write off the expenses.
  • You can easily change your business setup in the future, should you need to expand or another formation suits you better.

So, sole trading can be ideal for a number of reasons, not least among which is the ease of starting your business. However, before you can start trading or offering your services, you need to meet certain legal requirements. Some of these apply to everyone, while others apply only to some.

Legal requirements to start a business, applicable to all

Legal requirements to start a business

The following legal obligations apply to everyone who wishes to become a sole trader. They are pretty simple and concern your tax and National Insurance obligations.

Self-Assessment

The first thing to do once you have decided that you want to start your business as a sole trader is to register for Self-Assessment. Registering as a self-employed with HMRC is easy and quick.

Once you have registered, you will receive a Unique Tax Payer Reference (UTR). The UTR is a 10-digit number that is unique to you and helps HMRC identify you. You will need your UTR in order to file your tax form at the end of the financial year.

Keep in mind that you still need to register for Self-Assessment if you choose to work only part-time as a sole trader, while also keeping your day-job.

National Insurance

Once you have registered for Self-Assessment, you’ll need to register for National Insurance. There are two National Insurance contributions you will need to make: Class 2 and Class 4.

Class 4 National Insurance is automatically calculated once a year as a percentage of your profits. It will be automatically included in your taxes when you complete your self-assessment tax form.

Unlike Class 4, Class 2 National Insurance is a flat-rate contribution, calculated on a weekly basis. Even though the amount is relatively small, it’s important to register for Class 2, or you’ll be asked to pay for it all in a lump-sum in the future.

Also, you need to register for Class 2 National Insurance to qualify for state benefits. You can normally pay your Class 2 National Insurance through your Self-Assessment (although there are some exceptions).

Self-Assessment tax return

Your final legal obligation is to file with HMRC a self-assessment tax return. This form is used by HMRC to collect income tax on your profits.

As a sole trader, you need to fill in the tax return form at the end of the financial year (April 5th). Your income tax is calculated based on the profits you have filed. You need to pay the bill by January 31st of the next year.

Filling your tax return means you need to submit records of your sales and expenses as well as receipts and other pertinent records, so good bookkeeping is essential.

Additional legal requirements, applicable to some

Legal requirements that apply to some businesses

The legal requirements above apply to everyone who wishes to become a sole trader. However, depending on your exact circumstances, you may also need to meet the following legal requirements as well:

VAT

As a sole trader, it is not necessarily compulsory to register for VAT. Registering for VAT is optional up to a turnover of 85,000 pounds. Past this threshold, however, you have to register for VAT.

If you do, you will need to complete VAT return forms and update your bookkeeping records as well. You can register for VAT online, where you will receive your VAT number. Once you’ve registered, you’ll get an online VAT account through which you can submit your VAT returns.

So should you register for VAT? The answer isn’t as straightforward as you may think.

If your turnover is relatively low, you need to ask yourself about the costs and benefits. If you are not clear on whether you want to register for VAT, you should consider the following:

  • Will you be doing business with other businesses? If yes, then registering for VAT even below the 85,000-pound threshold might be advisable. This way, you’ll be able to claim back the VAT on your purchases and pass on the VAT you’ll be charging your clients without increasing the cost of your own products or services.  
  • Some people perceive VAT-registered businesses as more trustworthy than non-VAT registered ones.
  • You may need to pay an accountant to file your VAT returns. This could mean an extra cost for your business. Having said that, hiring an accountant from the start may save you a lot of money in the long run.

PAYE

As a sole trader, you can employ other people to help you in your business. You need to decide whether you want full-time or part-time employees. Or you may prefer to collaborate with freelancers.

If you choose to have employees in your payroll, you are legally required to register for PAYE (Pay As You Earn system). The PAYE means you will be collecting Income tax and National Insurance contributions from your employees, which you will then be paying to HMRC. You can register online for a PAYE reference number. You will also be required to set up an employer’s workplace pension scheme

Before you employ personnel, you will need to consider the following:

  • Will your business generate enough to pay them on a monthly basis? Your accounting bill may also increase if you include PAYE. If you choose to handle PAYE on your own, you may need to subscribe to an online bookkeeping service that also offers payroll services.
  • You can’t set your own wages. You are legally required to pay your employees at least the minimum wage.
  • Having employees working on your premises means you will need to get employers’ liability cover, which will increase your costs and expenses.
  • There are other legal requirements when it comes to personnel, such as pension payments, maternity leave, and creating a safe workplace.

Licences

Most professions don’t require a licence. However, some do: selling alcohol, for example, requires a licence. Doctors, accountants, lawyers, and other professionals also require one. Before starting your business, you should check whether you require a licence.  

You may also need various additional licences, depending on your line of business. For example, you may need one for the software packages you use in your business computer(s), the music you play in your shop, the e-mail list of clients to whom you will be sending promotional material (GDPR rules) or the photos you include in the websites you create for your customers.

Obviously, all these licences do not apply to all professions but being a sole trader does not mean you’re in any way exempt from needing one.

Recommended requirements

Recommended legal actions for businesses

The above tips cover the obligatory legal requirements of a sole trader with HMRC, depending on your line of business and your need to hire personnel and register for VAT.

However, you may also wish to consider some more aspects of running a business, which could save you time, money, and worries.

Bookkeeping

You are legally allowed to do your own bookkeeping as a sole trader. Bookkeeping for sole traders is generally easy and straightforward. But using a freelance accountant has never been more practical.

It’s a practice which could save a lot of money down the line, besides keeping your bookkeeping always up-to-date and accurate. Your accountant can help you identify potential savings and be aware of any legal changes.

Also, you would never miss any fine-carrying deadlines. Bookkeeping accounting for sole traders is relatively affordable and the cost can be included in your business expenses.

Extra insurance

Just like bookkeeping, extra insurance is not compulsory. However, it would be a good idea to include it in your expenses.

Remember that you are personally liable for any debts, legal claims or accidents that might occur in your business.

For instance, you may consider:

  • Public liability insurance: what if a customer came to your shop and got injured? Unless your clients never visit your office, this is one of the most common—and affordable—kinds of insurance for any business.
  • Professional indemnity insurance: what if a client sued you because they are not happy about the work you’ve provided?

There are many other types of insurance, such as fire insurance for your building, your tools or your machines. Deciding what you need to cover depends on your line of work and your finances.

You can change your business set-up in the future

One of the best things about being a sole trader is the flexibility offered by this business structure. However, being a sole trader also means that you are the business, which makes your personal finances entangled in your business finances.

Furthermore, larger businesses may look down on sole traders, preferring to work with companies. And you may wish to expand but fail to secure the proper financing due to the small size of your business.

All this means that there may come a time when your business outgrows the sole trading model. Things are looking promising and you start focusing on your business expansion.

Business growth often requires a partner who will fund your business and help it grow beyond what you can achieve on your own. This is when upgrading to a different business form, such as a limited company, becomes an enticing idea.

Thankfully, it is easy enough to move to a new business model if you reach a point when you feel that being a sole trader hinders your business from expanding.

Being a sole trader means that you have the flexibility to change your business form relatively quickly and easily.

And, having built your company from scratch by keeping in mind the necessary legal obligations of a sole trader, you will have gained the necessary experience to skyrocket your business, whatever comes next!