The 3 Tax Tips we discuss with Limited Company Contractors

Leaving the employment market and going out there as an independent contractor is becoming increasingly popular. Traditionally these roles were usually for those in the IT or Technology fields, but increasingly we are seeing many more contracting roles for HR, Finance, Marketing amongst other disciplines.

At ESDG Accountancy we have a track record of helping contractors manage their administrative obligations whilst ensuring they are as tax efficient as possible. All too often we take on contractors who have come to us after having a poor experience with their previous accountant – they tell us they wish they had met us sooner!

Below are 3 key strategic areas we explore with any new contractor client.

If you think you could benefit from our service, please reach out to us via our contact page. We are always happy to talk.

Is a Limited Company the right choice?

Traditionally, Limited Companies were incredibly tax efficient, the tax rate on Dividends and Corporation Tax were much lower than they are today. In addition, national insurance charged on employees was higher – making the difference even more stark. It was an obvious decision to set up as a Limited Company.

Following the last governments increase in Corporation Tax and cut to National Insurance, we spend much longer having conversations with clients on whether setting up as a Limited Company is the right choice for them. Limited Companies come with additional administration and therefore cost – they are a separate legal entity to you, the shareholder, so need their own sets of accounts and tax returns filing. Broadly speaking, the costs of operating a contractor Limited Company will be near enough equal to the tax saving through taking income as dividends instead of salary.

So when might you want to operate via a Limited Company? A key reason to do so would be if you are earning more than you need to spend to sustain your lifestyle. Leaving funds within the company means no personal taxes are due on those amounts. This strategy allows you to manage your personal tax exposure based on the level of drawings you take – meaning you can defer tax or avoid it completely. If your lifestyle allows, staying in the sub-£50k basic rate bracket allows you to pay only a few thousand of tax each year on dividends taken, which is an incredibly efficient personal tax rate of under 7% on average (note: your company still will need to pay corporation tax at 19% to 25% on pre-tax profits, before dividends are drawn).

Building on this strategy, you may be able to pay a Spouse or grown-up Children who assists with admin to also utilise their personal allowance or basic rate bracket.

Understand the next 24 months of tax deadlines and forecasted tax payments

For those new to contracting, Limited Company tax can be very overwhelming. You suddenly have to account for up to four different taxes now when previously your tax was automatically deducted via your payslip. You will likely be in scope of having to pay Corporation Tax, VAT Sales Tax, PAYE Payroll Tax and Personal Income Tax.

Many contractors who don’t give their tax sufficient attention (or employ a competent accountant to do so!) end up with a cashflow problem in their first year or two of trading. If you invoice a customer on Day 1 of setting up as a Limited Company Contractor, you will not need to pay the Corporation Tax due until almost 21 months after you receive the money into your bank account. It’s very important you regularly ring-fence profits within your business bank account to cover your expected future tax liability.

A good accountant will happily explain the various taxes and help you understand what is due and when. They can help put systems in place to ensure you put aside the correct amount for tax. Using a modern cloud accounting solution like Xero will help – it is well worth the ~£30 per month tax deductible cost and helps your accountant provide you with peace of mind over your tax liabilities.

Not overlooking your savings, pensions and life insurance

Now you are not an employee, you no longer are in-scope of pension auto-enrollment. If you do not take direct action yourself, you will only qualify for the state pension (£221 a week – probably similar or much less than your day rate!). Get in good habits from day 1 and understand the power of making regular employer pension contributions to yourself; the Director and employee of the company!

Employer Pension contributions from a Limited Company are incredibly efficient from a tax perspective. They count as an allowable business expense, meaning they are tax deductible form profits to offset against your corporation tax bill.

For most contractors, every £1,000 of pension contribution will relieve up to £250 of corporation tax. In addition, there are no immediate dividend or income tax implications on making a contribution. If you have already utilised your £50k basic rate bracket, making tax deductible employer pension contributions through your Limited Company is incredibly tax favoured compared to paying up to 39% income tax on dividends after already taxed company profits.

Lesser known than the above tip, is that your company can take out “Relevant Life Insurance”. A Relevant Life Insurance policy is an individual death in service policy that can allow an employer to provide tax-efficient life cover to the Directors. These premiums are tax deductible, and because they are paid through your company there are no personal income tax charges to pay on the amounts either. It is always worth exploring if you would be better off with a company held policy rather than a personal one – a regulated financial advisor is well placed to help here and we regularly refer our clients to speak with them.

Contracting via a Limited Company will mean your business is regularly holding large amounts of cash – this can be in the form of both accumulated profits as well as accumulated ring-fenced tax money that will be later due to HMRC. With the higher interest rates and inflation seen recently, it’s important to get a return on this amount. An easy solution can be opening a easy access Business savings account where returns of over 4% are easy to find. Longer term you can consider more sophisticated options such as making investments, holding companies or purchasing an investment property.

What’s next?

The above three strategies are for the longer term, and will help ensure you have a prosperous future as a contractor.

We ultimately provide peace of mind to our clients – they know they are keeping tax efficient whilst also knowing they are staying on the right side of HMRC.

If you would like an introductory conversation with us about managing your contractor accounts please reach out to us via our contact page – we are always happy to talk to new enquiries.

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