Tax for contractors explained

When you set up your contracting business, you have an awful lot of things to think about: developing your business plan, getting financial backing where appropriate, and developing and servicing a client base. As a contractor, one of the most important parts of running your own business is getting your taxes right.

If you are working on a contract basis between different organizations, then your tax situation can become quite complex to deal with. Here are some of the liabilities you will have to face up to if you set up as a limited company as opposed to an umbrella company – more on umbrella companies shortly.

Value added tax

If your turnover annually is £82,000 or more (it often changes in each government budget), you must register for VAT, though if it’s less, you could register for the Flat Rate VAT scheme, which could save you money if you’re a first year business. There can be hefty penalties if you don’t register but should and if you are late to pay your VAT.

Corporation tax

You pay this on your annual profits. You accountant will register your company for the tax, prepare your accounts and submit them. You need to pay your CT within nine months of the company’s year-end.

National insurance

You will be liable to pay NICs (National Insurance Contributions) on all salaries you pay your staff. You will have to pay it for yourself as well, depending on the level of your salary. You could choose to pay a salary below the threshold of contributions and make it up with dividends.

Dividend tax

If your company pays you a dividend and the income is less than the higher rate of income tax, you don’t pay tax on it, nor do you pay NICs.

Income tax

As an individual limited company contractor, you need to complete a self-assessment form every year, with the return being submitted each year by January 31. It’s possible, dependent on your circumstances, that you could have to make payments on account towards your tax liability in the current year.

Umbrella companies

These are very useful vehicles for contractors dealing with many other issues in their business. Essentially you become an employee of the umbrella company and are taxed exactly as if you were a traditional employee. You can make deductions for the fee for the umbrella company as well as aspects such as pension contributions. The rest of your income is then taxed at standard Pay As You Earn (PAYE) calculations. You’ll also have to pay NICs on that income.

Payroll will be processed on your behalf by your umbrella provider, and all deductions will show on the pay slip. It takes a lot of administrative work away from you and gives you more time to dedicate to building up and developing your business.

An umbrella company can also supply all necessary insurances and full statutory employment rights.

Planning for the future

Tax is a tricky business and it’s easy to get things wrong accidentally, leaving you open to penalties. Using the professional services of an umbrella company can remove that burden of worry.