Unlike salaried employment where earnings are subject to PAYE and NI deductions at set rates, being a contractor gives you greater flexibility. You can organise your employment structure to your advantage so you maximise net earnings. This, however, brings challenges.
The first of these is to ensure you’re not classed as undertaking ‘disguised employment’ under IR35 legislation. If you are, your income will be subject to PAYE and NI; otherwise, you have a choice in how you work.
However you structure your business, there are some taxes you must pay:
- Income Tax/NI depend on the level of your earnings. The challenge is to manage your business so you keep these to a minimum while still maintaining some NI payments for state pension and sick pay qualification.
- VAT is mandatory if turnover is above a certain level (£82,000 for 2015-16). However, it is usually recommended you register so you can reclaim VAT on expenses. You’ll have to charge VAT to clients but businesses won’t mind because they can reclaim it. You also have the possibility of going onto the Flat Rate VAT scheme, which can be very beneficial for some limited companies, but the rules and regulations can be complex and must be followed carefully. If you have ever considered (or never even heard of) the Flat Rate VAT Scheme, contact us today. We are happy to give you a free assessment as to whether this is a suitable arrangement for your business.
Many contractors start as self-employed since this is the simplest arrangement. However, you have to pay income tax on net earnings above your personal allowance plus Class 2 NI contributions at a flat weekly rate. The general aim is to reduce these outgoings.
Working through an umbrella company means you’re classed as an employee. Consequently, you pay NI and PAYE income tax after deducting fees and allowable expenses. The main advantage is all administration is handled on your behalf.
The arrangement of choice is normally to set up a limited company and operate within it. This has additional costs and complexities in respect of the returns that need to be provided but has advantages in the overall level of tax paid. Since the company is a separate legal entity to you as a director and employee, separate taxes are payable:
- Income Tax/NI are due, generally through self-assessment, on any salary paid to you. It is normal to pay a salary below your personal allowance so no tax is payable, but which is sufficient to pay some NI.
- Corporation Tax is levied on company profits, after deducting expenses including your salary. The rate for 2015-16 is 20% when annual profits don’t exceed £300,000, the tax payable within nine months of the company year end.
- Dividend Tax is due on dividends payable to you. This may well be the bulk of your earnings since dividends are taxed at a lower rate than salary, have no NI deducted and credit is allowed to reflect payment out of taxed income. However, the arrangement is changing from 2016-17, reducing benefits from this payment type.
Making Your Choice
Identifying the advantages of each structure and calculating the net benefits can be a complex process made worse by changing legislation. Using Phoenix Cloud Accounting removes any worries because tax is paid when due and everything else is taken care of. Contact us today for your free assessment.