Tax survival guide for Limited company contractors

It was Benjamin Franklin who once said that the only two certainties in life are death and taxes. As much as we wish he was wrong, Mr Franklin was certainly onto something. As a Limited company contractor you are legally required to pay a variety of taxes to HM Revenue & Customs. To help navigate the complex jargon, specialist contractor accountant ClearSky Accounting has put together a handy guide to contractor tax.

Corporation tax

All Limited companies are subject to tax on any profit that they make. Corporation tax is essentially a levy on any money that is left over once all business expenses, including your salary, have been deducted from your company turnover.

For example, if you were to turn over £100,000 in 2013/14 and you had £30,000 in business expenses, then you would pay corporation tax on £70,000.

The rate of corporation tax you pay depends on how much profit your Limited company generates. Those with an annual profit up to £300,000 are charged the ‘small profits’ rate of 20%. Companies that fall above this threshold pay a slightly higher rate. This can be as high as 23%, but is due to be cut to 21% next month and 20% in April 2015.

VAT

Value Added Tax, or VAT, is charged on most business-to-business and business-to-consumer transactions. Once your annual turnover reaches £79,000, you are legally obliged to register for VAT. The standard VAT rate currently stands at 20%.

If your VAT-inclusive turnover falls below £150,000 a year then you may benefit from the flat-rate VAT scheme. Rather than paying VAT on every transaction, you pay a fixed percentage based on your company’s annual turnover. This percentage varies depending upon your sector. For example, IT consultants are charged 14.5% whereas those working in building and construction only pay 9.5%. You may remain on the scheme until your VAT-inclusive turnover reaches £230,000.

The amount of business purchases you make – whether that’s IT software, computer equipment or safety boots – will ultimately determine which scheme is best for you. As a general rule of thumb, Limited companies that make a large number of business purchases should remain on the standard VAT rate, whilst occasional purchasers would benefit from the flat-rate scheme.

PAYE

Assuming that your assignment falls outside of IR35, a low salary topped up with company dividends is the most tax-efficient way of drawing an income. This is because company dividends are exempt from National Insurance contributions (NICs).

The Pay as You Earn (PAYE) scheme deducts income tax and NICs from an employee’s salary. In order to minimise their tax liability, most Limited company contractors pay themselves a salary that takes into account the various income tax thresholds.

The income tax rates for 2013/14 and 2014/15 are as follows:

As the director of a Limited company, you are liable for both employee and employer NICs.

The current and upcoming rate for employee NICs are:

The current and upcoming rate for employer NICs are:

Directors’ duties

As the director of a Limited company you are required to produce and file key documentation with HMRC and Companies House. Failure to meet statutory deadlines could result in a late filing penalty and a potential increase on your overall tax bill. Accuracy is also crucial when it comes to managing your company accounts. For unintentional and careless mistakes, HMRC can impose a fine worth up to 30% of your overall tax bill, whilst deliberate errors may see what you owe double in size.

Remember that, by law, all Limited company contractors must maintain accurate and detailed financial records for at least the past six years.

Author is Daniel Mepham, accounting director at ClearSky Accounting. 

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