Saturday, 21 September 2013

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.

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

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 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.

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