How to set yourself up as a Self-Employed Contractor?

There are many different options when it comes to getting set up as a self-employed contractor and one size does not fit all. Therefore, it is important to make an educated decision on what is best to suit your business and the target audience you are catering to. How should I set myself up is one of the most frequently asked questions for us so we have put together the below guide to help you make the right decision for your business.

What is self-employed?

Firstly, let’s look at the definition of being self-employed. Gov.uk defines as: ‘A person is self-employed if they run their business for themselves and take responsibility for its success or failure.’

Therefore, the status of being self-employed does not indicate a specific type of consultancy business or payment vehicle. Instead, it simply means that a person works for themselves on a contract basis without specifying how they are set up to do that. In most cases self-employed individuals are not subject to employment law, meaning they do not have the same rights or responsibilities as an employee, but there are exceptions depending on the contract as well as the employment status as a shareholder or an office holder of a Ltd company. You can be both employed and self-employed simultaneously, simply meaning that you run a business alongside your permanent employment, and pay tax on self-employed earnings separately.  

Different options for your self-employed business

There are a few different options to register as a self-employed contractor, but the two most common ways to run a business in the UK are through registering as a Sole Trader or setting up your own Private Limited Company.

SOLE TRADER

• Most common way to work as a self-employed individual. At the start of 2022, 56% (3.1 million) of the private sector businesses in the UK were set up as Sole Traders or Sole Proprietors

• If you have earned more than £1000 from self-employment between 6th of April and the 5th of April the following year, you will need to set up as a Sole Trader with HMRC by registering for self-assessment. This would need to be done at the latest by the 5th of October after the end of the tax year you became a Sole Trader, and you will need to have a National Insurance number in the UK to register

• Setting up as a Sole Trader is the easiest option to set up a self-employed business

• As a Sole Trader, your business is not a separate legal entity, effectively meaning that you are your business, and your personal assets are your business’ assets

• You can keep all your profits after paying tax on them, but you are also personally liable for any losses your business makes. This could mean you lose personal assets if your business accumulates debt

We will cover the way you can set yourself up as a Sole Trader, and how you pay tax and NIC in the next section. ​

PRIVATE LIMITED COMPANY

• Private Limited Company is the second most popular option in the UK for people to register as self-employed. At the start of 2022, 2.1 million businesses in the UK (37%) were set up as Limited companies

• A Limited company is a distinct legal entity and separate from the owner, meaning it has its own assets, but also all profits and losses belong to the company

• If the Limited company is ‘limited by shares’ which is usually the case for businesses that make a profit (i.e. not not-for-profits), this means the company has shares and shareholders, and the company can keep any profits it makes after paying tax

• Can be a one-person business, meaning by forming a Ltd company you will become the Director of the company, but it can also hire people as employees

• You will need to be at least 16 years old and not be disqualified from being a Director of a Ltd company (such as a history of bankruptcy). Although, you do not have to be based in the UK, your business will need to have an address in the UK (as opposed to a PO box). Note: this can be your home address, but please be aware that this correspondence address will be publicly available on Companies House website 

Alternative options are entering into a Partnership or setting up a Public Limited Company (PLC). The latter would require a minimum share capital investment of £50,000, you will need to have at least two company shareholders and a qualified Company Secretary.  

The process of setting up as a Sole Trader

• Easy set-up which can be done online

• You will need to have an NI number

• You can trade under your own name, or you can choose a name for your business

• You will simply need to register for self-assessment and Class 2 (and Class 4) National Insurance with HMRC to get your Unique Tax Reference number (UTR)

• Your UTR number will be sent out to you by post 10 days after registering for self-assessment, or you can see it earlier in your Personal Tax Account.

• You will need to keep all business records (invoices and expenses) for your tax return.

• You must inform HMRC by the 5th of October if you need to complete a tax return, which you can do yourself or appoint an accountant

HMRC will calculate what you owe, and you will need to pay your bill by the 31st of January.

The process of setting up as a Private Limited Company 

• Set-up is a bit more complicated

• You will need to be at least 16 years old, not be disqualified from being a Ltd Company Director and have a service address in the UK

• Choose your Ltd company name – this needs to be unique (unlike sole traders). You can check name availability here.

• Register your company with Companies House to make it official. This can be done online or by post using form IN01. You will have to pay a registration fee which varies based on method of registration

• At the same time, you will also need to register for corporation tax

• After the end of the first financial year, you will need to file first accounts with Companies House and complete a Company Tax Return.

• The tax is paid on company profits, and the rate is based on the amount of profit made

You can pay yourself a salary via PAYE, which is a tax-deductible expense, and you can also pay yourself dividends.

Please note that regardless of whether you are set up as a Ltd company or operating as a Sole Trader, you will need to register for VAT if your annual turnover exceeds £85,000 (or if you are based outside the UK). 

The pros and cons of Sole Trader vs Private Limited company

There is no one-size-fits-all approach when it comes to setting up as a self-employed contractor, but below are some of the key pros and cons to consider.

Pros of Sole Trader

• Easy and free to set up. Plus easy process to complete self-assessments

• You do not need to have a separate bank account

• The Intermediaries legislation does not apply to Sole Traders as your business is not considered a distinct legal entity

However, you may be still considered as a Worker under the employment law

• You can keep all the profits from your Sole Trader business

• Most SME businesses are happy to work with Sole Trader suppliers

• Privacy - Your annual accounts and personal details are not publicly available on Companies House, unlike it is for Limited Company freelancers

• It is an easy way to be both employed and self-employed simultaneously.

• You can start freelancing before you are fully set up as a Sole Trader

• Less paperwork to complete, and fewer tax requirements which means easier accounting - fixed overheads are limited

• Easy to change your Sole Trader business to a Ltd company

Cons of Sole Trader

• No legal separation between you and your business means your personal assets are at risk if things go wrong.

• Solution: make sure you have a comprehensive contract, professional indemnity and public liability insurance covers in place to reduce the risk. Nowadays, many businesses require freelancers to have insurance covers in place before they can start working for them.

• Generally speaking, recruitment agencies are unable to process your payments as a Sole Trader where you are contracted under the agency contract, and would therefore have to pay you via PAYE or umbrella (ITEPA section 44), although there are exceptions to this

• Limited funding opportunities available for Sole Traders due to the lack of legal separation between an individual and the business, which also causes problems if you try and sell your business, and/or with transfer of ownership.

• Some organisations, especially bigger businesses that rely on freelance resource may stipulate that they only work with Ltd company suppliers due to increased risk of providing an incorrect employment status caused by the lack of legal separation.

Pros of Limited Company

• Potentially a slightly higher take-home pay - where a Sole Trader would pay a fixed Class 2 NIC and then Class 4 NIC and tax on profits at varying rates, a Ltd Company Director can take out dividends which are not subject to NIC and pay themselves a salary via PAYE which may attract NICs depending on the sum. You will also need to register with HMRC for self-assessment to report this income.

• Separate legal entity and with that the liability is limited to the business meaning the Director is not liable for any debts personally.

• Because of the legal separation between the business and its Director, the self-employed status is therefore clearer which gives higher credibility and therefore opens up more opportunities in terms of working with bigger organisations that do not contract with Sole Traders due to greater risk.

• With the Intermediaries legislation (IR35) applying to Ltd companies, you do not carry the liability of incorrect or missing assessments and thereby any incorrectly paid tax, where the client has the responsibility of checking the employment status under the IR35 working rules. It is easier to sell and transfer a Limited company given it is a separate legal entity.

• It is easier to sell and transfer a Limited company given it is a separate legal entity.

Cons of Limited Company

• Set up process is more complex, plus you have to pay to register your company, and you will need to have a separate bank account.

• Being subject to IR35 legislation means that the business engaging you through your Ltd company has the responsibility of checking the employment status for tax purposes. This means if considered as inside IR35 (off-payroll working rules apply), your tax and NIC will be deducted at source, whether that is through company payroll or an umbrella.

• If the company is exempt from the IR35 working rules (under the SME exemptions), you as the Director of your Ltd company have the liability and responsibility of assessing your employment for tax purposes and carry the liability for any incorrectly paid tax.

• No privacy – all your company details, as well as some of your personal details, are available to the general public on Companies House. That includes your annual balance sheet.

• Complex accounting and tax requirements, which means unless you are a qualified accountant yourself, you will need to use an accountant which means additional overheads.

• Changing from a Ltd company to a Sole Trader is a lot more complex.

As explained through the pros and cons, there is no right or wrong when it comes to your set-up as a self-employed contractor. Ultimately, it will come down to your business – the size, the target market, and future objectives – that will help to determine the best fit.  

We recommend that you consult an accountant who can advise you on the legalities for both Ltd company and Sole Trader set-up, and together find the best solution for you and your business.