It might seem like there is quite an obvious answer to this, but there are nuances that affect your tax position, your legal status, and even your eligibility for government support. These distinctions became particularly important during the coronavirus support schemes, when some people qualified for help and others did not.
Sole Traders
The terms self‑employed and sole trader are interchangeable. Self-employed is the one that is more commonly used but sole trader is the term used by HMRC. However, they both mean the same thing: you’ve set up a business and you’re not working for an employer.
You can trade under a business name without registering a company. For example, Joe Bloggs could run his business as Joe Bloggs Coffees. Legally, he would need to show “Joe Bloggs trading as Joe Bloggs Coffees” on certain documents, but he wouldn’t need to register with Companies House.
Company Directors
The key distinction is whether you’ve registered a company with Companies House. Once you do, you’re no longer a sole trader - you’re a director of that company. Directors are automatically employees of their company and have a different legal and tax status.
Running your business through a company can bring benefits, such as limited liability if the company gets into debt, and potential tax advantages. But it also changes how you take money out of the business.
How Directors Can Pay Themselves
Directors can take money from their company in three main ways. The first is through the payroll, by registering for PAYE and running a monthly payroll. Salaries are tax‑deductible for the company, which can be an advantage.
The second is by repaying any money they’ve loaned to the business, such as start‑up funding. This can be withdrawn without tax implications, and in some cases the company can also loan money to a director.
Finally, directors can take dividends, which are distributions of profit to shareholders. Dividends must be paid in proportion to shareholdings, though in many small companies the director is the sole shareholder so this is straightforward. Dividends are taxed at lower rates than salary, making them an attractive option.
Tax Returns
Both sole traders and company directors may need to complete an annual self‑assessment tax return, though there are some exemptions in certain circumstances.
Coronavirus support
During the pandemic, the differences became very clear:
- Sole traders were eligible for government support of up to £2,500 per month under the Self‑Employment Income Support Scheme.
- Company directors could furlough themselves if they were paid through PAYE, receiving support under the Job Retention Scheme.
- Directors who relied mainly on dividends, however, had no equivalent support available.
Questions?
Understanding whether you’re a sole trader or a company director isn’t just about terminology — it shapes your tax obligations, how you pay yourself, and what support you might be entitled to. If you’re considering moving from sole trader to limited company, or want to review how you’re currently paid, we can help you weigh up the options.
