There are two ways to maximise your take-home pay as a contractor – by negotiating the best contract rate, and by not paying more tax than you have to.
Depending on whether you are an umbrella or limited company contractor, there are a number of taxes you will encounter.
Limited companies are separate legal entities from their directors, so your company will pay taxes on its profits, and you (as an individual) will be liable to pay tax on any income you receive from your company.
All companies pay Corporation Tax (CT) on their annual profits.
The rates of CT increased significantly from April 2023 onwards. Although companies still pay the old 19% rate for profits up to £50,000, a new 26.5% rate applies to profits between £50,000 and £250,000. Profits over £250,000 p.a. are taxed at 25%.
Your accountant will register your company for CT after your company is incorporated, and will prepare your Annual Accounts each year, and submit them to Companies House (the registrar of companies in the UK), and HMRC.
You must pay your Corporation Tax within 9 months of your company year-end.
Find out more in our Corporation Tax guide.
Value Added Tax
Most contractor companies also register for Value Added Tax (VAT).
VAT applies to all the services you provide to your contracting clients, and you can reclaim VAT on purchases you make via your company (subject to the conditions of any special VAT scheme you join).
The standard rate for VAT (which you charge on invoices sent to your clients) is 20%.
You need to submit an online VAT return to HMRC each quarter, together with an electronic payment.
If you choose to pay via direct debit, you have at least an extra 7 days to pay your VAT, and also a handy safeguard against forgetting to make the payment manually.
You must register for VAT if your annual turnover is £85,000 or more (2023/24). Most accountants will advise you to register regardless, as you can reclaim the VAT on eligible purchases you make through your company.
You could benefit financially by joining the Flat Rate VAT scheme, which provides a discount for new companies during their first year in business. Unfortunately, in recent years, HMRC has clamped down on the eligibility of smaller companies to use this incentive.
Find out more in our dedicated guide to VAT.
You pay income tax on your salary. This is processed via your company payroll.
Most individuals can use their Personal Allowance, which means the first £12,570 of income is tax free. Many contractors opt to pay themselves a salary which doesn’t go above this threshold.
Income tax rates apply as follows:
- £0 – £12,570 – Personal Allowance 90%)
- £12,571 – £50,270 – Basic Rate (20%)
- £50,271 – £125,140 – Higher Rate (40%)
- Over £125,140 – Additional Rate (45%)
If your income is over £100,000, your Personal Allowance is removed by £1 for every £2 you earn over this threshold.
Any NI owed on salaries is processed via your company payroll.
Companies pay Employers’ National Insurance Contributions (NICs) on all salaries paid to their staff. This applies to salaries of £9,100 or more.
If your company has 2+ employees, it might be able to benefit from the Employment Allowance. This cancels out your employers’ NI liabilities up to £5,000 p.a.
As an individual, you pay Employees’ NICs on the salary you draw down from your company.
Most contractors pay themselves a low salary, typically between the Secondary and Primary NIC thresholds, to minimise their exposure to both income tax and NICs.
For 2023/24, for example, the optimum salary for company directors is £12,570.
Read our dedicated guide to National Insurance.
As a company shareholder, you will also pay tax on the dividends your company declares. Unlike salaried income, dividend income is not subject to NICs, providing limited company owners with a significant tax benefit.
You pay any tax owed on dividends via self assessment.
Read more about dividends and how they are taxed.
Individual limited company contractors settle their income tax liabilities via self-assessment.
You must submit your tax return by 31st January each year together with payment.
You may also have to make two payments on account (31st Jan and 31st July) towards the current year’s tax liability.
The payments on account amounts assume that you will earn the same income this year as you did in the previous tax year.
Read more in our guide to the Self-Assessment process.
Umbrella Company Tax
As an umbrella company employee, you are taxed in the same way as you were as a traditional employee with your last employer.
After deductions have been made to your assignment income (employers’ NI, umbrella company fee, Apprenticeship Levy, and possibly pension contributions), your gross contract income is then subject to income tax and National Insurance.
Your umbrella provider will process your payroll on your behalf, and any deductions will be shown on the payslip.
Unless you have earned other income during each tax year (such as investment income, or income from letting out a property), you do not need to register for Self Assessment.
Check with your account manager, or an accountant, if you’re unsure whether any additional income should be declared via the self-assessment process.
Introduced in 2000, the Intermediaries Legislation (a.k.a ‘IR35’) could have a significant effect on your income as a limited company contractor if your contract work is deemed to be one of ‘disguised employment’.
If you are caught by IR35, then all your income will be paid in the form of a ‘deemed salary’ (subject to PAYE).
Clearly, you should take steps to ensure that your assignments fall outside the scope of IR35, otherwise, you will be significantly worse off as a result.
Umbrella company contractors are not affected by the IR35 rules, as they are already taxed as employees.
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