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IT contracting and working as a sole trader

Published on Jul 8, 2009 |

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Most IT contractors work via limited or umbrella companies. So, what is a sole trader, and why do contractors rarely work outside the structure of a company?

What is a sole trader?

There are nearly 3m sole traders operating in the UK currently, by far the most popular way of setting up in business.

Once you have registered with HMRC as 'self employed', you can start trading straight away.

Your personal and business income are treated as one for tax purposes, in contrast with the limited company model where personal and business assets remain separate.

Alongside taxation via the self assessment system, the 'self employed' must also pay Class 2 NI contributions, and Class 4 on profits over the lower threshold. Sole traders must register for VAT in the same way other businesses do if their turnover reaches the current threshold.

Clearly, sole trading is very much the 'hassle free' way to start up a business, but it is not as tax efficient as running a limited company, and your personal assets are also at risk if your business fails.

You can read more about sole trading, and how to register as self employed via our small business site, Bytestart.

Why don't contractors become sole traders?

There are several main reasons why IT contractors very rarely set up as sole traders:

1) Agencies only deal with companies

You can either become a PAYE 'employee' of the agency, join an umbrella company, or contract via your own limited company.

The Income Tax (Earnings and Pensions) Act 2003 does not permit self employment when a recruitment agency is involved, as if this were the case, agencies would be forced to treat contractors as 'employee's and deduct income tax and NICs at source.

2) Protecting your personal assets

As discussed above, as a sole trader, your personal and business liabilities are shared, so if something went wrong with your contract work and your 'business' ran up debts, you would personally be liable for any monies owed. The limited and umbrella company structures keep your business and personal finances separate.

3) Taxation

To put it simply, you will pay significantly less tax if you work via a limited company, compared to the sole trader route. Even if your contracts are caught by the IR35 rules, you will still be financially better off using the limited company structure.

You can find out more in our detailed guide to contracting and sole traders.