If you are contracting via own
Limited Company the amount of tax you will pay as a contractor will arise in
two different ways.
1) Which you pay
through your company and
2) That which you pay
personally.
The total amount of tax which you
will pay will be determined by the IR35 status of your contract.
If your contract falls within IR 35
you will inevitably suffer higher tax. This can be significantly detrimental and
so you should try to remain outside this if you can.
Let us explain each of the two categories
of tax in more detail.
1)
Taxes Paid Through Your Limited company
There are 3 different kinds of tax
which you will pay through Limited company
The first one is Corporation
Tax
This is effectively paid on net profit
of your company affairs.
All limited companies are subject to
Corporation Tax at rates varying between 0% and 30%.
Most contracting companies will pay
at the small company’s rate of 20%.
If your contract is not caught by
IR35, then you will most likely take the traditional route of low salary
combined with high dividends.
Since dividends can only be paid from
company profits, you will need to pay corporation tax at 20% of your net
company profit. Corporation Tax is payable 9 months after your year end.
Second is the employer's National
Insurance Contributions
This is a company cost based on the
amount of your gross salary charged at the rate of 13.8%.
If your contract is caught by IR35,
then your salary will be substantially higher as result and consequently the
amount of Employer’s National Insurance will be based on the IR35 salary.
If your contract is not caught by
IR35, then best advice would be to take a very low salary, potentially avoiding
Employer’s National Insurance contributions altogether. No National Insurance
contributions are chargeable on company dividends. Employer's National
Insurance is paid monthly.
Third one is VAT (Value Added
Tax)
If your company is registered for VAT
(which the vast majority of contracting companies are), then you will need to
charge VAT on your invoices to agencies/clients at the standard rate of 20%.
This money is collected by the
company on behalf of HMRC and must be accounted to them on a quarterly basis.
You will be able to make claims for input VAT (on your company purchases) by
deduction when you make the payment to HMRC. Most contractors register for the
VAT Flat Rate Scheme which is a means of obtaining a VAT rebate without the
need to account for the input VAT on all purchases. It often means an overall
VAT saving to the business which is even higher in the first year when HMRC
allow a 1% greater saving. VAT does not affect the profits of a company except
where there is a VAT ‘profit’ from the flat rate scheme.
2)
Taxes Paid Personally
There are 3 different
kinds of tax which you will pay personally to HMRC
First one is the Income Tax
If you are working in an IR35 caught
contract, then you will pay tax on deemed salary.
Our post on what should I do if my
contract is caught within IR 35 explains further.
If you are not caught by IR35, then
only a very small amount of your Income Tax liability will be deducted through
PAYE (on the low salary). On IR35 exempt contracts, you will receive dividends,
on which there will be tax credits covering your basic rate tax liability. If
your taxable income is less than the higher rate threshold, then you will not
have any further income tax liability.
Income Tax is paid monthly under PAYE
or twice a year in January and July if there is additional Income Tax to pay
under self-assessment.
Second is the employee's National
Insurance Contribution
If your contract is caught by IR35,
then you will suffer Employee’s National Insurance contributions on your
salary. These are currently 12% up to £797 per week and 2% thereafter on all
earning above this limit.
If your contract is not caught by
IR35, then you will pay very little, if any, Employee’s National Insurance
contributions, since the bulk of your income will be taken by dividends, which
do not attract National Insurance contributions of any kind.
Employee's National Insurance
Contributions are paid monthly.
And finally the Capital Gains Tax
You may be subject to Capital Gains Tax when you
close your company and make a capital distribution to yourself as shareholder.
This can be advantageous and is worth asking your accountant about in advance
of the business ceasing to trade. In addition, Entrepreneurs Relief can reduce
the amount of any final tax liability on cessation of trade.
I hope this helps. All the best
APJ Accountancy
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