Contractor tax: Limited Company and Personal Taxes Explained

If you are contracting via own Limited Company the amount of tax you will pay as a contractor will arise in two different ways.

1)     Which you pay through your company and

2)     That which you pay personally.

The total amount of tax which you will pay will be determined by the IR35 status of your contract.

If your contract falls within IR 35 you will inevitably suffer higher tax. This can be significantly detrimental and so you should try to remain outside this if you can.

Let us explain each of the two categories of tax in more detail.

1)    Taxes Paid Through Your Limited company

There are 3 different kinds of tax which you will pay through Limited company

The first one is Corporation Tax  

This is effectively paid on net profit of your company affairs.

All limited companies are subject to Corporation Tax at rates varying between 0% and 30%.

Most contracting companies will pay at the small company’s rate of 20%.

If your contract is not caught by IR35, then you will most likely take the traditional route of low salary combined with high dividends.

Since dividends can only be paid from company profits, you will need to pay corporation tax at 20% of your net company profit. Corporation Tax is payable 9 months after your year end.

 

Second is the employer's National Insurance Contributions

This is a company cost based on the amount of your gross salary charged at the rate of 13.8%.

If your contract is caught by IR35, then your salary will be substantially higher as result and consequently the amount of Employer’s National Insurance will be based on the IR35 salary.

If your contract is not caught by IR35, then best advice would be to take a very low salary, potentially avoiding Employer’s National Insurance contributions altogether. No National Insurance contributions are chargeable on company dividends. Employer's National Insurance is paid monthly.

Third one is VAT (Value Added Tax)

If your company is registered for VAT (which the vast majority of contracting companies are), then you will need to charge VAT on your invoices to agencies/clients at the standard rate of 20%.

This money is collected by the company on behalf of HMRC and must be accounted to them on a quarterly basis. You will be able to make claims for input VAT (on your company purchases) by deduction when you make the payment to HMRC. Most contractors register for the VAT Flat Rate Scheme which is a means of obtaining a VAT rebate without the need to account for the input VAT on all purchases. It often means an overall VAT saving to the business which is even higher in the first year when HMRC allow a 1% greater saving. VAT does not affect the profits of a company except where there is a VAT ‘profit’ from the flat rate scheme.

 

2)    Taxes Paid Personally

There are 3 different kinds of tax which you will pay personally to HMRC

First one is the Income Tax

If you are working in an IR35 caught contract, then you will pay tax on deemed salary.

Our post on what should I do if my contract is caught within IR 35 explains further.

Click here to read this post

If you are not caught by IR35, then only a very small amount of your Income Tax liability will be deducted through PAYE (on the low salary). On IR35 exempt contracts, you will receive dividends, on which there will be tax credits covering your basic rate tax liability. If your taxable income is less than the higher rate threshold, then you will not have any further income tax liability.

Income Tax is paid monthly under PAYE or twice a year in January and July if there is additional Income Tax to pay under self-assessment.

Second is the employee's National Insurance Contribution

If your contract is caught by IR35, then you will suffer Employee’s National Insurance contributions on your salary. These are currently 12% up to £797 per week and 2% thereafter on all earning above this limit.

If your contract is not caught by IR35, then you will pay very little, if any, Employee’s National Insurance contributions, since the bulk of your income will be taken by dividends, which do not attract National Insurance contributions of any kind.

Employee's National Insurance Contributions are paid monthly.

And finally the Capital Gains Tax

You may be subject to Capital Gains Tax when you close your company and make a capital distribution to yourself as shareholder. This can be advantageous and is worth asking your accountant about in advance of the business ceasing to trade. In addition, Entrepreneurs Relief can reduce the amount of any final tax liability on cessation of trade.

I hope this helps. All the best

APJ Accountancy

www.apjaccountancy.com

Tax Tips For Contractors – What should I do if my contract is caught within IR 35?

We often get asked about the best way to extract money from a limited company if contract is caught by IR 35.

First and foremost the only way to be sure whether your contract falls inside or outside IR35 is to have it review by professional accountant firm who are specialised in Contractor Accountancy services. (Note - @ APJ Accountancy we offer this free within our standard package service)

And by the way, It works on a contract by contract basis. So for one contract you may fall under IR35 but for some other’s you may be outside.

Be aware that every contract needs to be evaluated on its own merits and every contract can be different.

If you aren’t sure you can take the 10 minute Contractor IR35 Test to see if you are likely to be working under IR35 from HMRC website yourself.

Going back to the question about what is the best method to pay your self. In simple terms

For Income from all contracts that fall outside scope of IR 35 – you can pay yourself combination of small salary and big dividend to maximise your tax savings.

For income related to contracts that fall inside scope of IR 35 –

You may need to pay some additional PAYE and National Insurance on the taxable income from these contracts at the end of the financial year.

So your company will continue you pay you as usual throughout the year deducting PAYE and NICs as applicable.

At the end of the tax year you will need to check that you have paid the right amount of tax and NI by calculating the deemed employment payment due on the IR35 contract(s) undertaken.

If you don’t know much about deemed payment then a step-by-step guide for how to calculate ‘deemed salary’ and related NICs can be found on the HMRC website.

HMRC also have a IR35 ‘deemed salary’ calculation spreadsheet which can be downloaded.

Paste www.hmrc.gov.uk/ir35/ir35.xlt into your browser to download the spreadsheet.

Alternatively, contact us to discuss how we can be of help in calculating your IR35 contract(s) ‘deemed salary’ and NIC liabilities.

Visit www.apjaccountancy.com/contractor-accountant.html

Finally if you are wondering if I need to pay myself the deemed salary? Or Can I only take dividends, do they count? Then answer is:

You don’t need to actually pay yourself the salary, although it is a deductible expense for Corporation Tax purposes so it works out well when you have combination of contracts falling inside and some falling outside IR 35.

If you had paid yourself the salary during the year of the IR35 contract then the ‘deemed salary’ would have been less. You can’t retrospectively pay yourself the salary without incurring more tax.

You can, however, pay dividends and offset the ‘deemed salary’ against these. This claim will reduce the amount of reportable dividends for tax purposes.

I hope this helps. All the best

APJ Accountancy

www.apjaccountancy.com

How to Grow your Business

Tax avoidance versus Tax evasion….

A lot of people confuse tax avoidance and tax evasion. It can be a dangerous mistake to make!

As the former British Chancellor of the Exchequer Denis Healey said once:

“The difference between tax avoidance and tax evasion is the thickness of a prison wall”.

What can’t be stressed enough is that the two terms – and the actions each entails – are definitely not the same thing.

• Tax avoidance involves using whatever legal means you choose to reduce your current or future tax liabilities.

• Tax evasion means doing illegal things to avoid paying taxes. It’s the Al Capone path to financial freedom.

I’ve never evaded taxes, I don’t condone it, and I couldn’t tell you how it’s done.

Tax avoidance is another matter.  As the tax  have risen in the Western countries to pay down public debt, it makes sense for business to do what they can to reduce their tax burden without overly compromising other aspects of their lives.

The United Kingdom and jurisdictions following the UK approach (such as New Zealand) have recently adopted the evasion/avoidance terminology as used in the United States: evasion is a criminal attempt to avoid paying tax owed while avoidance is an attempt to use the law to reduce taxes owed

There is, however, a further distinction drawn between tax avoidance and tax mitigation. Tax avoidance is a course of action designed to conflict with or defeat the evident intention of Parliament.

Tax mitigation is conduct which reduces tax liabilities without “tax avoidance” (not contrary to the intention of Parliament), for instance, by gifts to charity or investments in certain assets which qualify for tax relief. This is important for tax provisions which apply in cases of “avoidance”: they are held not to apply in cases of mitigation.

I suspect this is largely a courtroom debate, caused by the Revenue looking to close down schemes of dubious legality created by planners for wealthy individuals.

So if I have to pull back my thoughts on where we started from, in very simple terms, tax avoidance is legal, but tax evasion is illegal and you risk prosecution for breaking the law.     

However, in some sophisticated cases the Taxman has been trying to blur the boundaries and claim some forms of tax avoidance are illegal.

A few examples will show the difference…

• The most common example of Tax Evasion amongst small businesses is making cash sales and not putting this money into your bank account or recording it in your accounting records, so the tax man will never know about it, or so you think!

• A slightly more thought out example, may be making up some forged purchase invoices. You write out the cheques to pay them with the name of the fictitious supplier on the cheque stub but it’s actually made payable to you and goes into a secret offshore account. Again, this is tax evasion and is illegal.

• Choosing to run your business as a Limited Company rather than as a sole trader in order to benefit from lower rates of tax paid by Limited Companies is an example of tax avoidance and is legal.

But it’s not always black and white, there are grey areas…

This may be because the law itself is in question or the facts of your particular case are in question. It often arises that HMRC may interpret something in one way, surprisingly to their advantage, but the accountant and the taxpayer may interpret it differently.

Please remember that HMRC do not make the law of the land and they often can get it wrong. Be prepared to stand up for your rights if necessary and don’t be bullied by them.

You should fight HMRC on technical grounds, but you need to be very sure of your facts and the law. If you can’t come to an agreement with HMRC, the matter normally ends up before the first tier Tax Tribunals who are an informal independent Tax Court to decide the matter. Many accountants don’t like going to the tribunal but they shouldn’t be afraid to go if they have a reasonable argument.

HMRC know it costs you money in accountants’ fees to argue with them and you may back down as the tax saved is not worth it after paying your accountant. In these situations look at getting your accountant to work on a no win, no fee basis for you if you aren’t already covered for Tax investigation issues.

The good news is that this is something we offer as standard within our accounting package which means you never have to worry about HMRC investigations. 

So if you are looking for accountants who aren’t afraid to challenge HMRC and fight your corner when you are right plus offers complete peace of mind for any HMRC investigation then get in touch with us. Please visit www.apjaccoutnancy.com or call 020 8931 0165.

Top Tips For Contractors

If you are already contracting or perhaps thinking of contracting then following 10 tax planning tips will help.

1. Go Limited

This may sounds immediately obvious but this is the first step any contractor/freelancer should take if they want to maximize their disposable income as far as legally possible. By setting up a limited company typical contractor/freelancer should be able to save around 20 – 30p in the £ of tax when compared to PAYE, umbrella co or being self employed.

2. Register for Flat Rate scheme of VAT

This is a potential winner for contractors/freelancers and is easier to administer. In some circumstances it can even save you tax! On the flat rate scheme you pay a fixed amount of VAT based on your turnover (including VAT). The fixed rate depends upon your profession/trade and is pre-determined by HMRC. You can only join this scheme if your turnover is expected to be lower than £150,000 per annum. And don’t forget for the first year you also get discount of 1% on normal VAT rate. So for e.g. it will be 13.5% instead of usual 14.5% for IT contractors. Also note that you can claim input VAT( this is vat you pay for purchasing items like computer etc) if it has been incurred prior to registering for flat rate VAT

3. Pay yourself a minimal (director) salary

The whole purpose of setting up limited company is take advantage of tax planning techniques in order to pay minimum tax. As at 2012/13, the amount you can take tax free is £8,105 which equates to £675 per month. This is the level of an individual’s personal allowance for income tax. The NIC free allowance is £7,605 and is payable at 12% for any salary amount between £7,605 and £34,870 and 2% on any amounts thereafter.

4. Claim All Eligible Expenses

There are a suite of expenses contractors/freelancers can claim that they do not realise. Expenses through your Ltd Co. attracts corporation tax relief at 20% (small business rate). However, there are strict rules on expenses and carelessness or ignorance does not bode well with the tax authorities.

5. Time your dividend extractions correctly

Dividends are a key tool for contractors/freelancers wishing to extract money out of their Ltd Co’s as drawings. Timing your dividend extraction can be a useful tactic in saving tax. In 2012/13 a contractor/freelancer has up to £31,500 (net) dividends (per shareholder) they can extract without incurring additional tax. Any amounts above this will incur an additional dividend tax of 32.5% (effective rate is 25% after the notional tax credit of 10%) and 42.5% for any amounts above £150,000.

6. Claim the AIA on capital assets

If you buy a capital asset (items such as laptops, hardware, fixture and furniture for your office), you can claim what is known as a first year capital allowance. The first year capital allowance is like an accelerated depreciation charge that provides tax relief in the year of purchase. In 2012/13, the first year allowance is £25,000 although there are transitional rules in place.

7. Ensure you comply with IR35 rules

IR35 is a piece of tax legislation that assesses contractors/freelancers based on the substance of their working arrangements. Being caught inside of IR35 can defeat the object of running your contractor/freelancer business through a Ltd Co. IR35 is assessed on a contract by contract basis.

8. Making your spouse/civil partner a partner or shareholder in your business to reduce your tax bill

If your spouse/civil partner earns less than the single persons allowance of £9,440 per year and helps out in your business you can pay them a wage to reduce your taxable profits. A wage of between £109 and £148 per week will not create a national insurance charge, but it will help your spouse gain credits toward the state pension and other state benefits.

9. Financial products

• Pension contributions

• Relevant life policy (life assurance)

• Investment products

Why not get your Ltd Co. to pay your pension contributions or life assurance premiums? This attracts corporation tax relief instantly and is a great way get the taxman to make a contribution to both. A director can set up an executive pension scheme and get the company to make (reasonable) contributions to get their life assurance paid through the company by way of a relevant life policy.

10. Entrepreneur’s relief

This is available to contractors/freelancers who are selling/closing down their Ltd Co’s. Once all other tax-efficient means have been utilised (director salary & dividends), entrepreneurs relief can be applied to any remaining funds in the company taxed at only 10%. However, this is subject to a whole host of criteria being satisfied.

To get more tips on tax planning for contractors log on to www.apjaccountancy.com