If you are already contracting or perhaps thinking of contracting then following 10 tax planning tips will help.
1. Go Limited
This may sounds immediately obvious but this is the first step any contractor/freelancer should take if they want to maximize their disposable income as far as legally possible. By setting up a limited company typical contractor/freelancer should be able to save around 20 – 30p in the £ of tax when compared to PAYE, umbrella co or being self employed.
2. Register for Flat Rate scheme of VAT
This is a potential winner for contractors/freelancers and is easier to administer. In some circumstances it can even save you tax! On the flat rate scheme you pay a fixed amount of VAT based on your turnover (including VAT). The fixed rate depends upon your profession/trade and is pre-determined by HMRC. You can only join this scheme if your turnover is expected to be lower than £150,000 per annum. And don’t forget for the first year you also get discount of 1% on normal VAT rate. So for e.g. it will be 13.5% instead of usual 14.5% for IT contractors. Also note that you can claim input VAT( this is vat you pay for purchasing items like computer etc) if it has been incurred prior to registering for flat rate VAT
3. Pay yourself a minimal (director) salary
The whole purpose of setting up limited company is take advantage of tax planning techniques in order to pay minimum tax. As at 2012/13, the amount you can take tax free is £8,105 which equates to £675 per month. This is the level of an individual’s personal allowance for income tax. The NIC free allowance is £7,605 and is payable at 12% for any salary amount between £7,605 and £34,870 and 2% on any amounts thereafter.
4. Claim All Eligible Expenses
There are a suite of expenses contractors/freelancers can claim that they do not realise. Expenses through your Ltd Co. attracts corporation tax relief at 20% (small business rate). However, there are strict rules on expenses and carelessness or ignorance does not bode well with the tax authorities.
5. Time your dividend extractions correctly
Dividends are a key tool for contractors/freelancers wishing to extract money out of their Ltd Co’s as drawings. Timing your dividend extraction can be a useful tactic in saving tax. In 2012/13 a contractor/freelancer has up to £31,500 (net) dividends (per shareholder) they can extract without incurring additional tax. Any amounts above this will incur an additional dividend tax of 32.5% (effective rate is 25% after the notional tax credit of 10%) and 42.5% for any amounts above £150,000.
6. Claim the AIA on capital assets
If you buy a capital asset (items such as laptops, hardware, fixture and furniture for your office), you can claim what is known as a first year capital allowance. The first year capital allowance is like an accelerated depreciation charge that provides tax relief in the year of purchase. In 2012/13, the first year allowance is £25,000 although there are transitional rules in place.
7. Ensure you comply with IR35 rules
IR35 is a piece of tax legislation that assesses contractors/freelancers based on the substance of their working arrangements. Being caught inside of IR35 can defeat the object of running your contractor/freelancer business through a Ltd Co. IR35 is assessed on a contract by contract basis.
8. Making your spouse/civil partner a partner or shareholder in your business to reduce your tax bill
If your spouse/civil partner earns less than the single persons allowance of £9,440 per year and helps out in your business you can pay them a wage to reduce your taxable profits. A wage of between £109 and £148 per week will not create a national insurance charge, but it will help your spouse gain credits toward the state pension and other state benefits.
9. Financial products
• Pension contributions
• Relevant life policy (life assurance)
• Investment products
Why not get your Ltd Co. to pay your pension contributions or life assurance premiums? This attracts corporation tax relief instantly and is a great way get the taxman to make a contribution to both. A director can set up an executive pension scheme and get the company to make (reasonable) contributions to get their life assurance paid through the company by way of a relevant life policy.
10. Entrepreneur’s relief
This is available to contractors/freelancers who are selling/closing down their Ltd Co’s. Once all other tax-efficient means have been utilised (director salary & dividends), entrepreneurs relief can be applied to any remaining funds in the company taxed at only 10%. However, this is subject to a whole host of criteria being satisfied.
To get more tips on tax planning for contractors log on to www.apjaccountancy.com