Tax information contractors

Many contractors and freelancers do not understand the tax implications of self-employment. On this page, you will find free tax information for contractors, including a thorough explanation of why it is more tax efficient to establish a limited company rather than working through an umbrella. Our free tax guide for contractors includes information about limited company taxes, corporation tax, VAT, National Insurance, PAYE, and more. We hope you will take advantage of this free information to make your business more tax efficient and more profitable. Why pay more tax than you need to as a contractor or freelancer?

Limited Company – The Best Option

The most important piece of tax information we can give contractors is that setting up a limited company is the best choice for remaining self-employed and still being as tax efficient as possible. A limited company keeps your tax liabilities to a minimum, to help you maintain compliance with the law and maximises your take-home pay. The only catch is one of doing your accounts correctly.

The UK has the distinction of being the most complex tax environment in the world. In fact, it sometimes seems as though we enjoy making the tax system as difficult as possible. However, setting up a limited company and complying with tax law does not need to be as complicated as some people make it. The contractor should learn what he/she can and utilise the services of an experienced accountant to make sure everything is done the right way.

Tax Considerations

A limited company in the UK is responsible for a number of different tax obligations. We have listed each tax consideration below, along with rates taken from 2014 as examples. Keep in mind that these rates may no longer be in play; they most certainly will change in later tax years.

• Corporation Tax – All limited companies must pay corporation tax of 20% on profits of less than £300,000. Taxable income for this purpose is calculated by subtracting legitimate business expenses from turnover. Corporation tax is due in nine months and one day after the conclusion of the financial year.

• Contractor Tax – Contractors pay taxes according to the amount of salary they receive from a limited company. There is quite a bit to this; we explain it in more detail later in this guide.

• VAT – The Value Added Tax (VAT) is essentially a national sales tax collected on goods and services. Most contractors are registered to collect VAT at 20% of the total sale. This amount is added to an invoice, collected by the contractor, and submitted to the government. Some contractors are eligible to register for the Flat Rate VAT scheme, a scheme that lets them pay less to the government than they collect. The scheme is a means of compensating contractors for acting as agents of the government to collect and pay the tax.

• PAYE – As with VAT, limited companies submit PAYE payments on behalf of employees, essentially acting as agents of the government. Under this scheme, the employer submits the employee's share of income tax. A limited company may not be required to participate in the scheme if it meets certain requirements.

• National Insurance Contributions – Although not officially called a tax, the National Insurance contributions (NIC) paid by employers are just that. Your limited company will pay NIC at a rate of 13.8% on any amount of salary over £153 per week that you or other employees earn. Contractors working for umbrella companies pay an additional 12% for National Insurance because they are employed by the umbrella company.

All of these taxes are subject to their own individual rules and regulations. When you contract with a company like ICP, we handle all of the calculations and reporting for you. We also advise you when to pay your taxes and how much is owed.

Contractor Tax Details

As the director of a limited company, you are paid a salary from the company's total revenues. This dictates that you have personal responsibilities insofar as taxes are concerned. Assuming you are taking income in the form of salary and/or dividends, you will be required to pay income tax at the same rate as employed workers. For example, your first £10,000 is tax-free; anything above £10,000 – and up to £41,865 – is taxed at 20%. The higher bands of 40% and 45% apply to higher income earners.

The amount of tax you pay becomes more complicated when you figure dividends into the equation. If your total income does not exceed the first tax band, any dividends you earn will not be subject to income tax or National Insurance. Once you enter the second or third tax band, dividends are taxed at a rate of 25%. Employer's NIC is never applied to dividends.

Self-Assessment Tax

Your limited company's tax obligations include Corporation Tax, VAT, PAYE, and Employer's NIC. As an individual earner employed as the director of your limited company, you will be required to file self-assessment tax returns just like any other UK worker. You will also likely need to make a down payment every July toward the following year's tax bill.

ICP considers it one of our primary responsibilities to ensure our clients remain in compliance with tax law. We keep track of how much tax you owe, when it is due and what might be required of you next year. Furthermore, we also advise you about how you can increase your tax efficiency by changing the way you do things. Finally, we handle all of the paperwork and reporting on your behalf. This includes the self-assessment tax return for a single company director.

It is true that UK tax law is complex. It is true that many contractors find it both confusing and overwhelming. Nevertheless, we believe you are still better off setting up a limited company and hiring us for accountancy services than to give up the tax efficiency and higher take-home pay of a limited company in favour of the convenience of working with an umbrella. Please do not hesitate to contact us to learn more. We would be happy to answer all of your tax related questions.