It might seem like there is quite an obvious answer to this, but there are nuances to this question that can affect your tax liability and recently became important when the government announced its coronavirus support packages as some people who work for themselves were eligible whereas others were not.
The reason it can get confusing comes about because due to multiple terms for the same thing, as well as a legal difference in terms of working status.
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. This is when someone has set up a business and is not working for an employer in any form.
You can have a trading name, for example Joe Bloggs could call his business Joe Bloggs Coffees. You do not need to have a registered company to have business name although there are rules about what you can and can’t call your business and how you refer to yourself. Joe would have to put Joe Bloggs trading as Joe Bloggs Coffees on certain documents, for example.
The key thing about being a sole trader is that you have not set up a company with Companies House. As soon as this happens, you are not classed as a sole trader, but you would be the director of the company. As such, directors are automatically employees of that company and have a different legal and tax status. There can potentially be a tax benefit to running your business through a company, as well as other benefits such as limited liability if your company gets into debt.
Directors can receive money from the company in one of three ways.
Firstly, they could be on the payroll. This requires registering for PAYE with HMRC and then running a monthly payroll service (something that Anderson Accounts can assist with if required). The benefit to this is that the company can claim the salary as a tax-deductible expense.
Secondly, if they have loaned money to the company, for instance as a start up loan, they can remove this without any tax implications. The company can also loan money to a director in certain situations.
Finally, they can take money out as dividends. Any money that is not paid through PAYE or a loan transaction must be classed as dividends. A dividend is a distribution of the profits of a company to the owners of that company – the shareholders. Shareholders must receive dividends in an equal ratio to their shareholding. Many small companies only have one shareholder – the director – so this is not normally an issue. With more than one director, profits need to be split according to their share ownership. Dividends are taxed at a lower rate than PAYE on the individual.
The most beneficial form of payment split will depend on each company’s circumstances.
Individuals who are sole traders or directors may need to complete an annual tax return (although they can be exempt in certain circumstances).
Sole traders benefited from support of up to £2,500 per month income from the government’s coronavirus support packages. Company directors were able to furlough themselves if they were paying themselves through PAYE, which would mean that they could receive support through the job retention scheme however there was nothing on offer for those who did not.