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Being a sole trader has considerable tax and
paperwork minimization advantages. As a sole
trader you will prepare accounts for your
business activities and then, from these,
prepare a personal tax return. Your income will
be taxed at standard personal rates - so your
tax rate on earnings above £29,400 (on top of
your tax free personal allowance) will be 40%.
As a sole trader has considerable latitude to
offset expenses against sales the amount of
income actually assessable for tax is reduced
and many sole traders pay a relatively low
proportion of their gross income in tax.
There is another substantial advantage too.
While some-one marketing their services through
a limited company may pay up to 20% of their fee
income in NICs, a sole trader usually only pays
7%.
So why doesn’t everyone become a sole trader?
Firstly the tax advantages are so great that the
Inland Revenue only grants sole trader status in
certain circumstances - usually dependent on the
number of customers that you have. Suppose you
are currently employed by an organisation and
you resign and then become a 'self employed'
contractor to the same organisation. The Inland
Revenue will argue that you are not self
employed, but that you actually remain an
employee of the client organisation and that you
should pay tax accordingly under PAYE (Pay As
You Earn).
If the organisation to which you are contracted
pays you without deducting PAYE tax and you, as
a sole trader, subsequently fail to pay tax on
your earnings from that contract, then the
Inland Revenue has the right to approach the
organisation and to require them to pay your
tax.
This is why so many organisations prefer to deal
with consultants through the medium of a limited
company, which hires out the services of the
consultant, rather than hire the consultant
directly.
The second disadvantage of being a sole trader
is that you are personally liable to your
customers, creditors, employees and to agencies
such as the Inland Revenue and Customs & Excise
for performance of contractual obligations and
payment of NICs, income tax for yourself and
your employees and VAT. While you can use
insurance to protect yourself against certain of
these, in the end it is your personal assets,
your house and savings, that are at risk.
Thirdly being a sole trader is not appropriate
for every business, for instance if you are
setting up a business in conjunction with
colleagues, or backed by investors who may want
an exit strategy, incorporation is usually
preferable.
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