According to data from the UK government, there were approximately 3.2 million sole traders in the UK in 2021. But what is a sole trader? And how is this status different from a self-employed person, a contractor, a limited company, or an employee?
If you’re an employer who has only ever worked with permanent or temporary hires before, understanding the different types of independent workers can be confusing.
In this post, we’ll explain exactly what a sole trader is, and how this status differs from some other common business types for self-employed people. We’ll also run through some of the potential risks that companies should be aware of when engaging sole traders, and how you can avoid these common pitfalls.
What is a sole trader?
A sole trader is an individual who performs services independently for clients in exchange for money. Setting up as a sole trader is the simplest way of forming a business in the UK, because there is no legal separation between the business and the sole proprietor as an individual.
This comes with many advantages for freelancers who choose this legal structure, because they are in complete control of their business. They’re also not subjected to the same administrative and accounting requirements as they would be if they set up a limited liability company, for example. However, this status also comes with a risk, since a sole trader is personally liable for all debts or obligations held by the company.
Many people think that a ‘sole trader’ is an independent worker who works alone, but this is not necessarily the case. Many sole proprietors employ people to work for them, just as many self-employed people who work alone do so under a different business structure.
Sole trader vs. self-employed: what’s the difference?
The words ‘sole trader’ and ‘self-employed’ are sometimes used interchangeably, but they don’t mean the same thing. ‘Self-employed’ is a broad category that covers everyone who works for themselves rather than for an employer. This includes sole traders, but also other types of business owners, like directors of limited liability companies, for example.
What’s the difference between a sole trader and a limited company?
A limited liability company (LLC) is a different type of business structure in the UK. Unlike a sole proprietorship, an LLC is a legal entity that is separate from its owners and directors.
Setting up an LLC (also known as ‘incorporating’) can have other benefits to freelancers when it comes to finding clients. Many companies prefer not to work with sole traders because of (perceived and actual) risks to them in terms of things like tax liability and employment rights. We’ll cover some of these risks in more detail further on.
What’s the difference between a sole trader and a partnership?
A partnership is a business entity that’s similar to a sole tradership, except that it’s owned by more than one person. Each partner owns a specified percentage of the company, which determines how much of the company’s profits they receive and pay income tax on.
There are also limited liability partnerships (LLPs), which have the same type of structure as a partnership, but liability is limited like with an LLC. This type of structure is common in professional services firms such as solicitors or accountants.
Engaging sole traders: Risks and Regulations
There are many advantages to engaging sole traders to perform services for your company. You can engage a sole trader for a short period of time, and pause or end your agreement when you no longer need their services. This can help you make significant savings compared to hiring a full-time employee.
You’ll also save on the various costs associated with hiring employees, such as tax, National Insurance and equipment, since sole traders are responsible for paying for these things themselves. Plus, since being a sole trader doesn’t come with the administrative and financial burden of operating an LLC, for example, you might find that prices are lower when you engage this type of independent worker.
However, there are also certain risks involved, which companies who want to work with sole proprietors should be aware of.
False self-employment: what you need to know
Sole traders have very few employment rights compared to traditional employees. For example, they don’t qualify for the National Minimum Wage, sick pay, or holiday pay. They are also responsible for paying their own tax and National Insurance contributions.
This lack of statutory rights means that bad employers sometimes try to pass off workers as sole traders when their actual relationship suggests that they are really employees. And it’s not just unscrupulous companies with bad intentions that need to be aware of this: false self-employment can also occur by accident when all parties are operating in good faith. Many companies avoid engaging sole traders for this reason.
In an employment tribunal, whether someone is operating as an independent worker or an employee is determined not by the contract in place, but by the actual circumstances of their working arrangements.
Genuinely self-employed people:
- Set their own working hours and location
- Provide their own equipment and materials
- Are not required to wear a branded uniform
- Are free to work with other organisations
- Have the right to engage employees and outsource tasks
- Have genuine control over pricing and invoicing
In other words, if you engage a sole trader, you can dictate what work should be done, but not how, where, or when the sole trader completes the work. If there is found to be a relationship of ‘supervision, direction, or control’, you could be found to be operating under a false self-employment arrangement, which can result in legal action against your company.
Tax liability for companies
Employers are responsible for paying tax, National Insurance and other contributions for their employees. When you engage a sole trader, on the other hand, you don’t have to pay these charges. This means that engaging sole traders instead of hiring employees can save businesses money.
However, in cases where employers are found to have an employee-employer relationship with a worker who is supposedly self-employed, they can be held liable for all of the tax and other contributions that they should have paid for the whole time the employee has been working for them — which can add up to a sizeable bill.
Companies can also face fines and legal action from HMRC for misclassifying an employee as a self-employed worker.
Right to work and background checks
When you hire employees in the UK, you are required by law to ensure that they have the right to work in the country. This involves checking documents such as passports, visas and other documentation that proves their immigration status if they are not UK citizens.
The same obligation does not apply to businesses that engage sole traders. However, if you engage a sole trader who is later found to be an employee, you could face legal consequences for hiring someone who doesn’t have the right to work in the UK.
Even if the person you engage is genuinely self-employed, it’s still a good idea to do your due diligence and make sure they have the right to work in the UK. Even if you haven’t technically broken the law, companies can face negative PR and other consequences if they are found to have engaged illegal workers.
Whether you’re hiring an employee or engaging a sole trader, it’s also important to perform background checks to ensure they are responsible and reliable. With an employee, you can simply contact their previous employers or ask for references — but this is trickier when you’re taking on a sole trader.
Do sole traders need to be insured?
Since sole traders are not employees, they are not always covered under general business insurance policies. If you engage sole traders, it’s important to make sure your employer’s liability insurance covers them as well as your employees.
Depending on the nature of the work you take on a sole trader for, they may also need to have their own insurance. Make sure you’re clear on any insurance requirements and the insurance they hold before you enter into an agreement with a sole trader.
Engage sole traders with confidence with CXC Comply
Engaging sole traders can be a great way to access extra, flexible support for your business, without having to commit to making a permanent hire.
While the sole trader sector in the UK is large, it’s a market that’s often avoided by the outsourcing and MSP community, due to a lack of understanding about what a sole trader is, and concerns about potential tax liability and employment rights disputes.
Our workforce compliance solution, CXC Comply, can help you to determine the correct legal status of any sole traders you engage, and assist your organisation in staying compliant with the law. Through our easy-to-use online portal, we can help you to engage the best talent, quickly and securely. We’ll even take care of right to work and background checks for you, so you can be sure you’re engaging someone who’s both reliable and authorised to work in the UK.
Interested to see how CXC Comply could help you engage sole traders? Contact us to book a free demo today.