What is the Difference Between a Sole Trader and a Contractor?

In the UK, a self-employed business owner can be known as a sole trader or a contractor. The key difference is that a sole trader refers to a business structure whereas a contractor describes a work arrangement. Here, we explore the main differences between the two and delve into the potential benefits and drawbacks of both.

What is a Sole Trader?

A sole trader is known as being the simplest form of business structure in the UK for self-employed individuals. It is also the most common.

When you operate as a sole trader, you (the individual) are the business. There is no legal distinction between the two meaning you are responsible for its successes and debts.

When we make reference to a sole trader, we are talking about the individual responsible for the success of their business. This person owns the business and is not employed by an external company or person. They are responsible for keeping their own accounts, submitting tax returns and making National Insurance Contributions (NICs) and their tax is not paid through PAYE.

As a sole trader, you are also individually liable for any losses that the business incurs.

How do you Register as a Sole Trader?

Sole traders need to register for Self-Assessment with HMRC and submit an annual tax return. As a sole trader, you do not need to register a company name – it can just be the name of the individual; however, if you prefer, you can trade under a business name.

How Does Tax Work for a Sole Trader?

As a sole trader, you pay income tax on your business profits through the Self-Assessment system. You may also need to pay National Insurance contributions (NICs), specifically Class 2 and Class 4 NICs.

Who is Liable as a Sole Trader?

When you are a sole trader, you have unlimited liability. This means that should your business suffer financially, your personal assets (including your home or car) could be used as collateral to cover your business debts.

Who has Control as a Sole Trader?

As a sole trader, you have total control over your business and any decisions made. This means that any employees are under your control and you will need to handle all aspects of employment such as payroll and compliance.

Benefits of Being a Sole Trader

As the most common set up for self-employed individuals in the UK, it is no surprise that operating as a sole trader has many benefits including: 

• Easy to set up
• Minimal admin
• All business profits after tax are for the individual
• Total control and flexibility

Cons of Being a Sole Trader

However, there are some drawbacks to being a sole trader. These include: 

• Individual liability for any loss
• Less flexibility when it comes to tax
• Can appear less professional to potential clients

What is a Limited Company Contractor?

A limited company contractor is someone who does client work on a contractual basis such as project work. They are contracted for fixed periods or specific projects to provide their services to clients.

Contractors tend to have plenty of autonomy when it comes to how they deliver their work, including where they work and their schedule. They also have the choice of working for multiple companies or choosing to take on contracts that work for them. This offers them a lot of independence and flexibility.

When it comes to registration, contractors are registered with Companies House which can often give them greater credibility than sole traders. They are set up as a business which means they are separated from the individual. As a result, the individual is not personally responsible for any losses incurred by the company.

What is the Business Structure for a Contractor?

Contractors have the choice to work as sole traders, limited companies, or under another company. The way they choose to structure their company will affect their tax obligations, liability, and administrative responsibilities.

They will work on a contractual basis where they agree to provide specific services for a client within a fixed time period. These contracts tend to have clear deliverables, given start and end dates and payment terms.

How Does Tax Work for Contractors?

Tax for contractors can often be more complex, especially if they choose to operate as a limited company. If that is the case, they may be subject to the IR35 legislation which decides whether they need to be taxed as an employee or as a business. When taxed as an employee, they will be subject to PAYE whereas if taxed as a business, they will benefit from the associated tax advantages.

Who has Liability for Contractors?

Liability for contractors will depend on how they choose to structure their business. If they operate as a sole trader, they will have unlimited liability. However, if they choose to work through a limited company, their personal assets will be separate as the company has its own legal identity. This means that the individual is not personally responsible for any company debt.

What are the Benefits of Being a Contractor?

There are many benefits to being a contractor including: 

• You are ont personally liable for losses
• It is tax-efficient
• When you are registered with Companies House you are more credible to clients
• A high level of flexibility 

Drawbacks of Being a Contractor

However, there are some cons of being a contractor including:

• No guaranteed income or employee rights
• Lots of admin and paperwork
• Public business accounts through Companies House
• IR35 implications