The life of a sole trader is relatively simple and straight forward when it comes to the set up and regulations that this type of business structure needs to follow.
How to set up as a Sole Trader
Unlike a Limited Company there is no formal process in place for a sole trader to set up their business. A sole trader simply just starts to trade. They do however need to register with HMRC to complete a self assessment tax return which will be used to record the profit from the business and work out any taxes that are due. Registration can happen online at the GOV.uk web site: https://www.access.service.gov.uk/registration/email
As part of the registration process you will get what is known as a Government Gateway log on. The Government Gateway is the name that HMRC give to their online systems. You will need this log on in order to file your self assessment tax return in the future.
Set some time aside to go through the registration process as there are a number of questions asked and options to select. Fill in the questions as best that you can. Where you are unsure of an answer make the selection most appropriate to you or provide the best estimate that you can.
Deadline to register
The deadline to register your sole trader business is by 5th October in your business’s second tax year. For example, if you started to trade on 10th May 2023 then the latest date that you can register with HMRC is by 5th October 2024. However this is the final date by which you should register and you could be fined if you do not register in time. Of course, the best advice is always to register as soon as possible.
Business name
The informal approach for a sole trader does mean that there is no process in place which allows the registration of a business or trading name for the self employed sole trader. So for example if Jane Smith has a gardening business trading as Poppy Garden Design Services there is no register where this business name will be recorded. There’s little in the way that Jane could do to protect the business name.
As a sole trader you can call your business anything you want to although you cannot call yourself a company or use the word Limited after the name as this would imply that you were operating via a Limited Company. So Jane couldn’t call her business Poppy Garden Design Services Limited unless it was incorporated at Companies House. Of course you could register the name of your business at Companies House if it is unique enough and worthy of protection although doing so will put you into the reporting responsibilities associated with a Limited Company which has an administrative cost attached to it. So think hard before you go down this route.
Business address
Similarly to the business name there is no formal Registered Office for a sole trader business in the same way that there is for a Limited Company. The main address for a sole trader would be the home or business premises if there were any. Obviously this does mean that customers and suppliers may see the home address of the sole trader business owner on correspondence and invoices but, aside from that, the address would not be listed on a public register anywhere as it is with a Limited Company.
Getting paid to a business name
One thing to be aware of if you do use a trading name is that banks operate payee checks when someone pays an invoice or bill online. They can reject payments where the name on the account does not match.
For example, if you raise an invoice to your customer in the name of Poppy Garden Design Services but your bank account is in the name of Jane Smith, when your customer came to pay the invoice it would throw up a mismatch for this payment. This can cause confusion for the customer and doubt as to if they are paying the right person. The simple way to resolve this is to ask the bank to add a trading name to your business bank account. For example Jane Smith trading as Poppy Garden Design Services. Trading as is often abbreviated to t/a.
Important accounting things to know
Paying your tax bill – if you pay your self assessment tax bill out of your business account you would record that payment as Drawings. This is because your tax bill must be met out of your own pocket.
Whilst there are no rules or laws that demand that you set aside money to meet your tax bill, it is sensible to budget for that as you go so that there are no shocks when you need to make the tax payment.
Your wages – as the owner of a self employed business you do not pay yourself a wage or take dividends and there are no formalities that need to be done when you take money out of the business.
If you pay someone else a salary or a wage then this is recorded as an allowable cost with the usual rules for payroll and registering a PAYE scheme applying.
Amounts paid into your business – if you put money into your sole trader business this would be recorded as Capital Introduced. You can pay as much as you want into the business at any time. Any money introduced to the business can be paid back to you at any time without any tax implications.
Your Capital Account – there may be many amounts that you pay into and out of the business. These amounts are kept track of through what is called “The Capital Account”. The Capital Account would show:
Balance brought forward from the previous year
Add
Profits in the year or deduct losses
Add
Capital Introduced
Less
Amounts taken out of the business as Drawings
Equals
Balance on the Capital Account carried forward
The Capital Account is something which would be detailed in the Balance Sheet although it is not a mandatory requirement for a sole trader to produce a Balance Sheet.
Keeping things simple
When you operate as a sole trader there are perfectly legal ways to make your bookkeeping and accounting much easier.
Turnover below £1,000 – The Trading Allowance
If your total turnover (business income or receipts not profit) is less than £1,000 each tax year then you do not have to register for or complete a self assessment (unless you meet other criteria for filing a self assessment or HMRC have asked you to complete a self assessment tax return in the past).
This exception is available by way of utilising “The Trading Allowance”.
With the intention of making life simpler for the self employed The Trading Allowance, a form of tax relief, was implemented in April 2017.
Of course any tax relief usually brings with it the added burden of ensuring that you properly comply with the rules as well as the necessary record keeping to prove it. So if you want to use this relief to exempt yourself from completing a self assessment tax return you will need to have bookkeeping records to show that your turnover was less than £1,000.
If your turnover does go over £1,000, no matter by how little, you must register and file a self assessment.
In the early days of starting a business, whether with the intention of this being your full time activity or you’re starting up a Side Hustle, you may make a loss.
Losses are not always bad, as long as they are planned, expected, containable and not a downward trend. Importantly losses can be offset against other income or, when starting out, carried forward to offset against future profits from your business.
So even if your turnover is less than £1,000 you may still want to register and complete a self assessment to take advantage of the loss that you’ve made.
Turnover above but costs less than £1,000
If your business turnover from your self employed business is over £1,000 then you do need to register with HMRC and complete an annual self assessment but you may be eligible to claim partial relief under The Trading Allowance rules.
This means that instead of claiming for all of your costs you can make what is known as a partial relief claim of £1,000 but this must not exceed your total income.
Simply put you would forgo claiming all of the actual business costs that you have incurred and claim a flat rate of £1,000 as costs against your turnover.
You do this by putting £1,000 into the relevant box on the Self Employment Supplement Short Form (called an SA103S). If your costs are over £1,000 then it would not be beneficial to use the partial relief rules and you would be better off recording your costs in the usual way. Of course to be able to assess if your costs are below the £1,000 threshold you would need to record them!
Practical advice on using The Trading Allowance
The Trading Allowance can be used by individuals with income from:
- self-employment
- casual services or miscellaneous income from casual earnings (e.g. babysitting, gardening services etc), commission and freelance income
- hiring personal equipment, for example, power tools
Use the Trading Allowance if:
- you’ve a very small amount of income
- little in the way of costs
- have not suffered a loss in the year
- have little intention of making this activity your main source of income
When you shouldn’t use the Trading Allowance
There may be valid reasons why the Trading Allowance will not meet your needs and the use of it should be avoided. These include if you:
- make a loss as you may want to carry this forward against future profits or even offset it against other income such as that from your main job if you’re operating a side hustle
- want to make voluntary Class 2 National Insurance contributions (the National Insurance paid by the self employed) so that you qualify for some benefits
- want to use your self employed income to claim Tax Free Childcare or the Maternity Allowance
- are a subcontractor and want to claim tax that has been deducted under the Construction Industry Scheme (CIS)
The Two Box Tax Return Approach – turnover less than £85,000
If you do have to complete a self assessment tax return for your self employed business then it’s useful to know that if your turnover is less than £85,000 you can complete the short version of the Self Employment Supplement (called an SA103S).
Not only that but instead of providing a breakdown of costs by the categories set out by HMRC in the cost boxes section on the SA103S form you can simply put the total of all costs as one figure in the relevant box.
You do not have to break costs down into categories although you may find this useful just for your own business management purposes.
Simplified Expenses
HMRC do allow you to simplify certain aspects of cost recording by employing the rules related to Simplified Expenses. These rules mean that you can use flat rates for certain costs rather than recording the exact amounts spent. The intention is to make your bookkeeping (record keeping) easier.
The Simplified Expenses rules are not compulsory. You would just use them if it suits you to do so. The rules apply to sole traders and unincorporated partnerships but not to limited companies.
The rules apply to costs in the following areas:
- business costs for most cars (except those designed for commercial use), goods vehicles and motorbikes
- working from home
- living in your business premises
Vehicle Costs
Instead of recording all of the costs associated with operating your vehicle and doing a calculation to work out the allowable business proportion of the costs you can use a flat rate amount for each mile travelledon business instead.
The rates that you can claim are:
Rate per mile | |
Cars & goods vehicles up to 10,000 miles | 45p |
Cars & goods vehicles over 10,000 miles | 25p |
Motorbikes | 24p |
You will need to record the miles travelled by tax year i.e. from 6th April to 5th April each year. The limits apply by tax year meaning that the 10,000 miles total is reset on 6th April each year.
Working from home
If you work at home you can claim a proportion of your home running costs as an allowable cost in your business. You’d do this by adding together all of your costs, working out the bit of the house that you use for business and the percentage of time that you use it for. That’s all a bit complicated.
So rather than work out the proportion of personal and business use for your home and allocate the costs incurred as appropriate, you can use a flat rate amount instead. This makes the record keeping much easier.
The rates that can be used depend on the number of hours that you work at home, see below, but you must work at home for more than 25 hours per month.
Hours of business use per month | Flat rate per month |
25 to 50 | £10 |
51 to 100 | £18 |
101 and more | £26 |
The use of home as office flat rates do not include telephone or internet expenseswhich you can claim through the business – well the business proportion of those costs anyway.
Living in your business premises
Although this area of simplified expenses will not apply to many, and you can skip over it if it’s not applicable to you, it is worth briefly mentioning the rules for those who live at their business premises. For example bed and breakfast owners, guest houses or small care homes.
Again rather than working out the total costs of the premises splitting them out between your private and business use, you can use the simplified expenses flat rate amount and simply deduct that amount from the total expenses for your premises leaving the amount to include in your accounts. The amount to deduct depends on the number of people living in the premises as follows:
Number of people | Flat rate per month |
1 | £350 |
2 | £500 |
3+ | £650 |
Full Rules
The full Simplified Expenses rules can be found on the HMRC web site.
Cash Accounting
HMRC will allow most self employed businesses to operate through what is called the cash accounting system.
Very simply this means that you record your income received and costs paid out as they occur.
Cash accounting rules can be use by small self employed businesses with a turnover of less than £150,000 per year.
Accruals accounting
This section is included just as a note as if you can use cash accounting then you can pretty much ignore accruals accounting. It’s included here just so you are aware of it. As a general rule of thumb, most sole traders can operate within the cash accounting rules. So the need for knowledge of the more complex accruals accounting rules can be avoided.
However if you are not eligible to use cash accounting then you have to follow traditional accounting rules known as accruals accounting. In addition there are some instances where you may not want to use the cash accounting rules, such as:
- loan or bank charges of more than £500 which you want to put in the accounts
- you have stock in your business
- the business needs to obtain finance and the lender wants to see the accounts
- there are losses that you want to offset against other taxable income
Accruals accounting is more complicated and may be an area where you’ll need to employ an accountant to make sure that you adhere to the rules. If you do want to understand this area more then refer to the full rules on the HMRC web site.
What to file and when
Knowing what you have to file and when is important in making sure that you meet your regulatory responsibilities and do not end up with a fine, penalty or something worse. To avoid you forgetting about the key responsibilities it is worthwhile setting up annual reminders. Just like the birthdays of family and friends, it’s important to add your key filing dates into your calendar, scheduler or whatever tool you use to remember important events. Here’s a summary of what needs to be filed, when and where:
Summary
What | Frequency | Who |
Self Assessment | Annually | HMRC |
PAYE | Monthly | HMRC |
VAT | Quarterly | HMRC |