Many contractors contract through Limited Company because it is the most tax efficient way to function. This is because a Limited Company typically takes a small salary, which minimises PAYE (Pay As You Earn) and NIC (National Insurance Contributions) liabilities. The remaining income will be in the form of dividends.
Before anything, you have to determine whether you are inside or outside contractors IR35. IR35 is tax legislation in the UK. It seeks to battle tax avoidance by workers giving services to clients through Limited Company. You have to prove that you are not a “disguised employee” or you are outside IR35. A true contractor will most likely be outside of IR35.
If you are exposed by IR35, you will suffer higher tax. Many contractors consider Limited Company because it increases their take home. However, you need to know that you will be liable for a number of business taxes including personal taxes. Here are some taxes to consider for Limited Company contractors:
You have to know that all limited companies are subject to Corporation Tax. This is at 19%. If you are caught by IR35, your expenses and salary will be equal to the company’s income. With this, the company will make little net profit and very little payable Corporation Tax.
If you are not caught by IR35, you will take a low salary combined with high dividends. Remember that dividends are only paid from company profits. With this, you need to pay Corporation Tax at 19% of your net company profit. It is payable for nine months.
Value Added Tax
Majority of contracting companies are registered for VAT. If your company is registered for this, you need to charge VAT on your invoices with a standard rate of 20%. Do not worry because VAT does not affect the profit of your company. The company will collect VAT on behalf of HMRC (Her Majesty’s Revenue and Customs).
NIC is considered a company cost based on the amount of your gross salary. The rate is 13.8%. If your contract is caught by IR35, your salary will be higher and the amount of NIC will be based on your salary. If your contract is not caught, the best thing to do is to take a low salary to avoid NIC. NIC is not chargeable on company dividends.
Personal taxes include Income Tax and Capital Gains Tax. If your contract is caught by IR35, your whole income from the company will be subjected to PAYE; it will then be subtracted at the source. If you are not caught, a small amount of your Income Tax liability will be subtracted via PAYE. For IR35 exempt contracts, you can receive dividends having 7.5%, 32.5%, and 38.1% rates. If you close your company and distribute the capital to yourself as a shareholder, you are subjected to Capital Gains Tax.
Your goal here is to be outside IR35. You need proof if HMRC deems necessary. You can show documents and contracts but it can be set aside if the judge sees it as a sham. What you can do is to show your working practices to prove that you are a contractor or self-employed.