Understanding the legal requirements of being a sole trader

If you’re considering setting up your own small business then you may well decide to trade as a sole trader and not a limited company. Before you set up as a sole trader, you should be aware of the legal requirements.

Legal requirements of being a sole trader include choosing and protecting your company name, registration with HM Revenue and Customs (HMRC) for Self Assessment, keeping accurate records and ensuring you pay your Personal Income Tax and National Insurance on time.

In this blog I’ll cover some the legal obligations that you need to be aware of as a sole trader.

1. Register for Self Assessment

If you are considering becoming self-employed then there are steps you must take to notify HMRC of your employment status. You should notify HMRC that you are self-employed and register for self-assessment, this will ensure you pay the correct amount of income tax.

If you’ve never been self-employed before or you haven’t ever completed a self-assessment tax return, you’ll need to register online with HMRC if you decide to be self-employed. When you register online, you’ll be able to create a Government Gateway user ID, which you’ll need in future for all your dealings with HMRC.

After registration you’ll receive a letter with your Unique Taxpayer Reference (UTR) – keep this safe as you’ll need it, or your accountant will need it to file a tax return and pay tax.

For more information on how to register with HMRC for self assessment tax returns click here.

2. Choose a name for your sole trader business

Naming your business can be one of the hard but fun things when setting up and starting out.

However, before you come up with what you think is the perfect sole trader company name, it’s important to know the following:

Sole traders are not allowed to use the following terms in their name as it would be misleading around the legal status of the business. So, as a sole trader you cannot use:

• Limited (Ltd)
• Limited Liability Partnership (LLP)
• Public limited company (Plc)

Your company name can’t be offensive and should not contain prescribed sensitive words.

This includes names that suggest your business is connected to the government or is of national importance (such as British or International) unless you have obtained specific permissions to use them.

Protecting and registering your company name

Many sole traders switch to operating a limited company as their business grows. So, at the point of choosing your company name, it’s wise to your research and check if any other sole traders (or current limited companies) are using the business name you want.

You can search the Companies House register for existing company names to avoid using another company’s name. You will not be allowed to register a limited company name with companies house if it is the same or very similar to a current limited company in the UK.

You can register your sole trader name as a limited company name (even if you don’t trade as a limited company initially) this will protect the name for your future use should you choose to switch to being a limited company in the future.

You can find out more about how to register a company here. Here at dns accountants, we offer a service to form and register a limited company name here.

Trading as

When you’re a sole trader, you can use a ‘trading as’ name different from your own name. ‘Trading as’ is often abbreviated to the letters t/a for simplicity.

If you are self-employed and choose to use a brand name rather than your own name, you’ll need to use a ‘trading as’ name on official documentation like invoices and business bank statements.

You can also enter it in your tax return, sharing it with HMRC as part of Self Assessment.

3. Keep good records for your sole trader business

Whilst you do not need to send your records into HMRC when you submit your tax return, you need to keep details of any business expenses and income (both before you start trading and during trading) so you can:

• work out your profit or loss for your tax return.
• show them to HM Revenue and Customs (HMRC) if asked or if they investigate you.

You’ll need to keep accurate records of:

• all sales and income.
• all business expenses.
• VAT records if you’re registered for VAT
• PAYE records if you employ people
• records about your personal income
• any grants you received to help your business.

4. Submit a self assessment tax return every year

HMRC normally collect income tax from employees directly through the PAYE/payroll system of their employers. However, if you’re a self-employed sole trader and run your own business you need to submit a tax return to HMRC once a year to declare your income and for HMRC to work out the tax you owe.

You need to report your yearly income and expenses to HMRC every year via a self assessment tax return. This needs to be submitted by midnight on 31st January each year. You can find out more about filing your income tax return here.

HMRC use this tax return information to calculate how much income tax you will need to pay.

5. Pay your tax bill

How much tax you will pay depends on the amount of profit you make, and how much income you earn in a financial year, which starts on 6th April and ends on the 5th April the following year.

Profit is subject to tax once your income exceeds the tax-free personal allowance threshold, which for the 2022/23 tax year is £12,570 and will remain so until 2026.

In most cases, sole traders must also make payments on account (POA) towards the following tax year. Payments on account are advance payments towards the following year’s tax bill and will be based on you earning the same level of income/profit next year as you did this one.

The advance payments are split into two equal payments, with the 1st POA due on the 31st January and the 2nd POA by 31 July.

Midnight on 31st January is the deadline for filing you tax return and for paying your Self Assessment tax bill. If you don’t pay by the deadline - you could face a £100 fine for missing it. Find out more about self assessment deadlines and penalties here.

If, when your tax return is calculated for that year, your payments on account were less than the tax due, you will make a balancing payment, and if you overpaid, you should receive a refund from the HMRC.

6. National Insurance

As a sole trader, you’ll need to pay National Insurance contributions (NICs) on your income, but unlike full-time employees who only pay Class 1 National Insurance contributions, you’ll need to pay Class 2 National Insurance and Class 4 National Insurance contributions.

• Class 2 if your profits are more than £11,908 a year.
• Class 4 if your profits are £11,909 or more a year.

While Class 4 is automatically calculated and included in your taxes, Class 2 is calculated on a weekly basis.

Most people pay Class 2 and Class 4 National Insurance through Self Assessment.

7. Register for VAT voluntarily or compulsory

Sole traders must register for VAT (Value Added Tax) with HMRC, if their VAT taxable income is greater than £85,000.

The business receives a VAT registration certificate when they register the business with HMRC. The certificate confirms the VAT number, details for submission of first VAT return and payment, and effective date of registration. The effective date is when the business is officially subject to VAT rules.

A sole trader can register voluntarily; apply for a VAT registration number, if the turnover is less that £85,000, except if all sales are VAT exempt. You may opt to voluntarily register for VAT because there can be advantages such as:

Whether voluntary or compulsory, VAT registration offers many benefits:

• VAT can be reclaimed on most goods or services purchased from other businesses.
• If your customers are VAT registered businesses, they will be able to reclaim the VAT from HMRC. Your prices will still be competitive, and you can recover the VAT on your costs.
• Small businesses can give the appearance of being bigger and more established. This can be very appealing to customers, lenders, investors, and suppliers because they will assume the company’s turnover is in excess of the VAT registration threshold.
• VAT-registered businesses are given a VAT number. This can be displayed on invoices, letterheads, websites, and other forms of business stationery. Again, this can be appealing to other firms, many of whom may not be willing to do business with a non-VAT registered entity because it is considered too small.
• Voluntary registration can be backdated by up to four years if sufficient evidence can be supplied to HMRC. This means that a business may be able to reclaim VAT paid on equipment that it is still using.
• VAT registration will force you to keep more accurate records, which will ultimately be beneficial to the running of your business.

VAT can be complex and an added burden to a business. dns accountants offer a VAT registration and VAT return service to register you for VAT and complete and submit your VAT returns directly to HMRC.

8. Employing people

Having employees working for you can be exciting but brings with it more legal responsibilities. Once you employ your first employee, you need to register as an official employer with HMRC and sign up to Pay As You Earn (PAYE) at least five working days before your business’s first payday.

After registering with HMRC, your legal responsibilities as an employer include:

• Set up Employers’ Liability Insurance.
• Create a written employment contract.
• Create a written statement of employment particulars.
• Offer a salary that is above the National Minimum Wage.

9. GDPR

The General Data Protection Regulations (GDPR) came into effect in May 2018.

General Data Protection regulations govern how businesses collect, store and handle an individual/customer’s data, and determine the penalties for those who fail to comply.

Any business that holds personal information about an individual/customer, whether electronic or on paper, will need to ensure that they can prove that they have obtained consent to hold/use that individuals data.

Unlike large businesses, sole traders and the self-employed don’t need to appoint a data protection officer. However, they could be fined up to 4% of their annual turnover for failing to get sufficient consent to collect, hold and use a person’s data.

10. Insurance

You may need some types of insurance and in some cases, this will be a legal requirement. The type of insurance you need depends on your type of business. Here are a few common examples:

• Car or vehicle insurance.
• Public liability insurance.
• Employers’ liability insurance.
• Professional indemnity insurance.
• Building and contents cover.
• Goods in transit insurance.
• Business assets and equipment cover.

11. The Construction Industry Scheme (CIS)

If you work in the construction industry as a subcontractor or contractor you should know your responsibilities in relation to the Construction Industry Scheme (CIS).

Under CIS rules contractors must deduct money from payments to subcontractors and submit these to HMRC as advance payments towards the subcontractor’s tax and National Insurance.

If you’re a contractor in the construction industry, you must register for the scheme.

Find out more in the dns accountants CIS guide here.

Summary

While there are a number of legal requirements and responsibilities of becoming a sole trader, being a sole trader is less complex than running a limited company and it can be a quicker and simpler way of starting a business.

With great accountants and tax advisors, you can ensure you meet all your legal requirements when it comes to accounting, tax and government requirements.

Download our sole trader guide here for even more information about setting up as a sole trader. For personal help and advice on becoming a sole trader and sole trader legal obligations, contact our team on 03300 886 686, or email on enquiry@dnsaccountants.co.uk.

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.