Anyone who is considering becoming a contractor should know that accountancy experts consider setting up and working through your own limited company is by far the most tax efficient way to operate. 

The tax system can be complex, but setting up a limited company and dealing with the relevant admin need not be an onerous task or one which takes up a huge amount of your time. When you consider the potential benefits of doing so, it is definitely worth learning more about how you could save money and prepare for a financially stable future. This guide will give you answers to some of the questions you might have about how the financial side of things works.

Limited Company Tax (rates correct as of April 2017)

For the purposes of understanding your tax position as a limited company, it may make it easier to think of the company as a separate entity, with your role as owner and employee of the company being completely separate.

Corporation Tax

Limited companies are subject to Corporation Tax. This is currently 19% on all profits for companies which earn less than £300,000. This rate is now also applicable on profits above £300,000. 

Your tax payment will be due 9 months and 1 day after the year-end, known as the financial year.

Employer's National Insurance Contributions

Whatever salary your company pays, you will attract a tax of 13.8% on any amount over the threshold of £153 per week.

If you work through an umbrella company, you will need to pay 12% National Insurance on your salary as well as 13.8 employer’s National Insurance as your own employer. This means your salary will cost you a total of 25.8% on your total amount of pay, once expenses and threshold allowances have been deducted.

VAT (Value Added Tax)

Most contractors are registered for VAT, which is chargeable at a rate of 20%. This sum is added to your invoices and paid to HMRC, so you are effectively collecting this tax on behalf of the government.

However, many of those contractors who charge VAT also register for the Flat Rate VAT Scheme which allows those collecting VAT to pay it to the government at a lower rate than they charge their clients. IT contractors, for example, usually repay VAT at a rate of 14.5% (and there is even a discount for the first year, meaning newly registered businesses can repay at 13.5%).

This means that you can keep the difference, and although this is then taxed as profit, it can still amount to a significant sum every year which is available to you as the owner of a limited company. You can find more information in our Flat Rate VAT Scheme guide. 

have a burning tax question

Contractor Tax – personal taxes (tax rates based on April 2017)

Income Tax including PAYE

When you start to take home an income in the form of a salary as well as dividends from your company, the administration can get a little more complicated. You will need to start thinking of your income as being earned over the fiscal year, from 6th April one year to the 5th April the next.
 
You will be entitled to a tax-free allowance of £11,500, and any salary you earn in excess of this will be taxed at a rate of 20%. The higher rate is paid on taxable income over the Personal Allowance from £33,501 up to £15,000 at 40%.  If you earn more than £150,000, you will be taxed at a rate of 45% on any amounts over this.
 
 
A taxpayer whose income is more than £43,000 (taking them into the higher rate tax band), will be liable for dividend tax at 32.5% as opposed to the 25% they would have paid prior to the changes made in 2016. This means that someone who takes £10,000 in dividends on top of their £43,000 will have to pay an extra £3,250 in dividend tax (32.5% of the extra £10,000).

National Insurance Contributions

There is no National Insurance rate for dividends, as opposed to salaried earnings which are subject to a rate of 12% on earnings above £157 per week, although.
 
PAYE income tax and National Insurance is payable quarterly, along with VAT, and your accountant will remind you of the dates well in advance to ensure that you are adequately prepared.
 
The number and varied nature of the applicable rates above may seem complicated, particularly as the threshold and allowances are subject to annual change which can be confusing. However, this is a simple breakdown of what is payable and when:

Company Liabilities

Corporation Tax – due 9 months and a day after year end
VAT – due quarterly
PAYE and National Insurance – payable quarterly 

Personal Liabilities

Your self-assessment tax return is due annually, with the deadline for submitting your paperwork and paying your bill being the 31st of January. It is likely that you will also need to make a payment on account in July as a down-payment on the next year’s tax bill.

How can Nixon Williams help?

Whilst negotiating the world of personal and business tax can seem complex, once you have your finances organised, it can be as simple as entering the relevant data into a spreadsheet and submitting it to your accountant. You should not let the tax system put you off pursuing your dreams of owning your own limited company, particularly as a specialist accountant can take all the stress out of it by offering advice, reminders, and expertise throughout the year.
 
Nixon Williams provides support to contractors with all of their financial needs. To see how we could help you, please get in contact with our New Business team on 01253 362062 or email newbusiness@nixonwilliams.com.  
 
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