Starting a Business in the United Kingdom

Understanding Sole Traders, the Self-Employed, and Limited Companies

Entrepreneurship in the United Kingdom offers flexibility, independence and a range of legal structures that can be adapted to different professional goals. Before launching a project it is important to understand the differences between operating as a sole trader, being self employed, or incorporating a private limited company (Ltd). Each model has its own tax treatment, liability level and administrative requirements.

1. Sole Trader

Definition: A sole trader is an individual who owns and runs the business personally. There is no legal separation between the person and the business, so the owner is responsible for profits and for debts.

When it is suitable:

• When the activity is small or at an early stage.
• When the financial risk is limited.
• When the person wants to start trading quickly without complex reporting.

Example: An electrician in London who works for local customers, invoices directly and declares income through Self Assessment.

2. Self Employed

Definition: Self employed describes a working status, not a legal structure. A self employed person works for themselves and is not on an employer’s payroll. A self employed person can still operate as a sole trader, in partnership or through a limited company.

When it is suitable:

• For independent professionals such as consultants, IT technicians or tradespeople.
• For people who want to choose their working hours and clients.
• For those who invoice different customers during the year.

Example: An IT consultant who provides short projects for several companies and invoices directly.

3. Limited Company (Ltd)

Definition: A limited company is a separate legal entity. It is registered at Companies House and offers limited liability to its shareholders. This means personal assets are protected if the company cannot pay its debts.

When it is suitable:

• When the business is growing and signing larger contracts.
• When the owner wants a more professional image.
• When there is a need to separate personal and business finances.

Example: A property maintenance business that begins to employ staff and decides to incorporate as “GreenCare Maintenance Ltd”.

Differences Between Sole Trader and Self Employed

These two terms are often used as if they were the same, but they refer to different ideas.

• Legal meaning: Sole trader is a business structure. Self employed is a tax and work status.
• Registration: A sole trader must tell HMRC that they are trading. A self employed person must also tell HMRC but could be operating through a different structure.
• Scope: Every sole trader is self employed. Not every self employed person is a sole trader.
• Liability: A sole trader has full personal liability. A self employed person who uses a limited company may benefit from limited liability.

Procedural Guide for London

The following steps reflect current United Kingdom practice for businesses based in London and follow HMRC and Companies House guidance.

A. Becoming a Sole Trader

Main references: HMRC “Set up as a sole trader”, Self Assessment, VAT registration guidance.

1. Confirm that the activity can start as a personal business.
2. Choose a trading name that is not misleading and does not include “Ltd”.
3. Register with HMRC for Self Assessment by 5 October following the end of the first tax year of trading.
4. Create or activate a Government Gateway account to file the tax return online.
5. Declare all income by 31 January and pay Income Tax and Class 2 and Class 4 National Insurance when due.
6. Register for VAT if the taxable turnover in a rolling 12 month period reaches £90,000.
7. Keep invoices, receipts and bank statements for at least five years after the filing deadline.

B. Registering as Self Employed

Main references: HMRC “Check employment status for tax (CEST)”, Self Assessment guidance.

1. Check that the person is really working for themselves and not as an employee.
2. Tell HMRC about the self employed status by 5 October after the first tax year.
3. File the Self Assessment return every year and pay Income Tax and National Insurance.
4. Update HMRC if at a later stage the activity is carried out through a limited company.

C. Forming a Private Limited Company

Main references: Companies Act 2006, Companies House incorporation rules, Economic Crime and Corporate Transparency Act 2023.

1. Decide that a separate legal entity is appropriate.
2. Choose a unique company name and a registered office in England and Wales.
3. Identify at least one director, at least one shareholder and any person with significant control.
4. Prepare memorandum and articles of association or use the model articles.
5. Incorporate online at Companies House and pay the digital fee of £50.
6. Tell HMRC about the start of trading within three months so that Corporation Tax can be assessed.
7. File annual accounts, submit the confirmation statement and keep statutory registers up to date.

Examples

The following examples show how a person who already works full time in London can start a small activity as a sole trader and how the tax is calculated.

Example 1: Full Time Employee with £10,000 Sole Trader Profit

Profile:

• Foreign national with settled status in the UK.
• Lives and works in London.
• Full time salary: £30,000 per year under PAYE.
• Starts weekend jobs as a sole trader and earns £10,000 profit in the tax year 2025/26.

Income position: Salary £30,000 plus sole trader profit £10,000 gives total income of £40,000.

Income Tax:

• Personal Allowance: £12,570.
• Taxable income: £40,000 minus £12,570 equals £27,430.
• All of this is in the basic band at 20 percent.
• Total tax on the year: £27,430 multiplied by 0.20 equals £5,486.
• The employer will already have deducted about £3,486 through PAYE on the £30,000 salary.
• The difference, £2,000, is paid through Self Assessment and corresponds to the tax on the extra work.

National Insurance: The sole trader profit of £10,000 is above the level at which Class 2 is treated as paid but below the Class 4 starting point of £12,570, so no Class 4 is due.

Net result:

• Sole trader profit: £10,000.
• Less income tax on that profit: £2,000.
• Less National Insurance: £0.
• Net additional income kept: £8,000.

This example shows that a person with settled status can add small private work in London, declare everything to HMRC and still keep most of the additional income.

Example 2: Full Time Employee with £25,000 Sole Trader Profit

Profile:

• Settled status and resident in London.
• Full time job: £30,000 per year.
• Starts a property maintenance activity as a sole trader.
• Earns £25,000 profit from this activity in 2025/26.

Income position: Salary £30,000 plus profit £25,000 gives total income of £55,000.

Income Tax:

• Personal Allowance: £12,570.
• Taxable income: £55,000 minus £12,570 equals £42,430.
• Basic rate 20 percent applies to £37,700 which gives £7,540.
• Higher rate 40 percent applies to the remaining £4,730 which gives £1,892.
• Total tax for the year: £7,540 plus £1,892 equals £9,432.
• PAYE on the salary has already covered about £3,486.
• Tax to pay through Self Assessment: £9,432 minus £3,486 equals £5,946.

National Insurance for self employment:

• Class 2 is treated as paid.
• Class 4 is 6 percent on profits between £12,570 and £50,270. The profit is £25,000 so the amount subject to 6 percent is £25,000 minus £12,570 which equals £12,430. At 6 percent this gives £745.80.
• There is no profit above £50,270 in this example so the 2 percent band does not apply.
• Total Class 4 National Insurance is therefore about £746.

Net result:

• Sole trader profit: £25,000.
• Less income tax due through Self Assessment: £5,946.
• Less Class 4 National Insurance: about £746.
• Approximate net income kept: £18,300.

This second example shows that when the sole trader profit is higher the person moves partly into the higher rate of tax and begins to pay Class 4 National Insurance, but the activity is still viable and the person keeps a significant part of what was earned.

Coming Soon: More Real-Life Business Scenarios

In the following weeks, we will continue publishing new examples and detailed case studies to help you understand how the business system in the United Kingdom works in practice. Each case will explore a different type of company, from sole traders to partnerships and limited companies, so you can clearly see how taxes, responsibilities and opportunities apply to each structure.