If you’ve thought about contracting and starting up your own limited company, which any accountant will tell you is the most tax-efficient route possible as it lends itself to good tax planning, but we’re always worried about how complicated the tax side was, then we hope you’ll find the following contractors tax guide helpful. It might not answer all your questions but hopefully, it will help fill in a few gaps.
Sadly there’s no getting away from it, tax is quite complicated. This shouldn’t stop you from forming your own limited company, taking advantage of the tax benefits and pursuing your goal of company ownership.
Limited Company Tax (tax rates based on April 2014)
Whilst discussing limited company tax it’s best to see the company as one entity and you, an employee and owner of the company, as a separate entity. This may seem strange but it really is the best way to think and will make it far easier to understand.
All limited companies have to pay Corporation Tax on their profits; the current rate for companies’ with profits under £300,000 is 20%.
This means if you invoice your client £100,000 excluding VAT over the year and have expenses which include any salary you pay yourself of £20,000, you will pay 20% on £80,000. The company’s corporation tax is due nine months and one day after the year-end, this is what accountants refer to as the ‘financial year’.
Employer’s National Insurance Contributions
Your company will pay 13.8% on any salary you pay yourself over the threshold of £166 per week.
If you work through an umbrella company ‘you’ will have to pay employee NI of 12% and employers NI of 13.8%, this means you’ll pay 25.8% on your entire pay fewer expenses and threshold allowances.
VAT (Value Added Tax)
As a contractor, you’ll more than likely be registered for VAT which is 20%. You charge this on your invoices and then give the money to HM Revenue and Customs (essentially you act as a tax collector for the government).
Most contractors also apply and register for the Flat Rate VAT Scheme which means you charge out at one rate 20% but then only repay at a lower rate, IT contractors usually use 14.5% (plus you get a first years discount of 1% so will just payback at 13.5%), with this being paid on the total gross invoice value and you keep the difference; sadly this then counts as a profit and is taxed along with your corporation tax, but could still add up to thousands of pounds per year which goes towards your overall income for year.
All you need to start a Limited Company
Discover all the intricacies of contracting through a limited company with our free downloadable guide.
What’s in the guide?
- Understanding legislation – what is IR35 and what could it mean for your business?
- Maximising your expenses – find out what business costs you can expense through your company.
- Making your business a success – a look at how to manage your time, market yourself and make your business a success.
Contractor Tax – personal taxes (tax rates based on April 2014)
Income Tax including PAYE
This does get a little complicated due to you taking money from your company both as for dividends (as the owner) and as a salary (as an employee).
This spans what accountants call the ‘Fiscal tax year’, so 6th April to 5th April and relates purely to your personal worldwide income.
Any income taken as salary beyond your personal tax allowance (£10,000) is taxed at 20% and then after the higher rate threshold (£41,865) will be taxed at 40% and 45% after £150,000.
It is also worth mentioning that once you earn beyond £100,000 your personal allowance will be reduced at a rate of £1 for every £2 of income until it is reduced to zero, so by the time you hit £120,000 your personal allowance will have disappeared, this effectively means that the £20,000 after £100k will have been taxed at 60%.
Special note for dividends – Up to the higher rate threshold (£41,865), the dividends will be subject to nil PAYE Income Tax and nil NI. Anything taken above this will be subject to a 25% higher rate dividend tax on the net dividend drawn.
Employee’s National Insurance Contribution
Firstly, there is no NI on dividends. You’ll just pay NI on a salary which is 12% on anything you earn above £166 per week until you reach £805 per week and then you’ll pay just 2%. PAYE Income tax/NI is, along with VAT, payable quarterly but your accountant will be able to advise you of these crucial dates.
Although not quite rocket science the above is fairly complex, especially as all the allowances, thresholds and rates often change annually.
It simply breaks down like this:
- Corporation tax – payable 9 months and 1 day after the year-end
- VAT – payable quarterly
- PAYE/NI – payable quarterly
Personal tax (self-assessment) – payable every 31st January, with potential payments on account in January and July (sorry even this sounds complicated).
Talk to a contractor tax specialist
We hope the above helps, please don’t let fear of tax stop you from following your business aims and goals, SJD the UK’s largest accountants for contractors support over 11,000 limited company contractors and freelancer’s all of whom felt nervous about tax, however with the support of a good specialist accountant there really isn’t too much to worry about tax-wise as they’ll help shoulder the burden.
If you have any questions about contracting or would like further tax and Limited Company advice please contact us on:
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