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Contractor tax liabilities can be minimised by using effective tax planning. While HM Revenue and Customs (HMRC) rules and regulations apply to everyone, there is no secret method to paying less tax. However, a good accountant will help you to make sure you are taking advantage of all of the available tax efficiencies.
The main benefit of working through a limited company as opposed to an umbrella company is that it allows more opportunities for tax planning as you can take your income through a mixture of salary and dividends. The other main savings that you can make by operating through a limited company are related to National Insurance and the Flat Rate VAT scheme, for more information about the benefits of working as a director of your own limited company you may find our advantages and disadvantages of limited company guide useful.
One of the main benefits available to contractors is the ability to claim business costs as expenses and in doing so you will receive tax relief on the amount. When you claim an expense the cost is deducted from your company’s profits, you will only incur corporation tax on your company profits and so the higher your expense amount the lower your company’s taxable profits will be.
A business expense is defined as a cost that is incurred wholly and exclusively for business purposes. Some examples of costs that could be claimed as a business expense include equipment, computer software, business travel and accountancy fees. To find out more about what expenses you could claim as a contractor or how expenses can affect your tax bill you may also find our guide to expenses for contractors helpful.
The majority of contractors find that they benefit from using the Flat Rate VAT Scheme as opposed to the standard VAT scheme. The Flat Rate Scheme was introduced to simplify the VAT scheme for small businesses and basically means that you charge the standard VAT rate of 20%, but pay back HMRC at a lower rate. The rate that you pay back will depend on your profession.
You can find a full list of rates per industry in our guide to the Flat Rate VAT Scheme.
If you don’t pay your tax bill on time then you could be liable for a penalty, which can rise if your payment continues to be late. Being organised and putting money aside for tax bills can prevent this from happening.
IR35 is a government legislation that was put in place to combat contractors who are in disguised employment and are enjoying the benefits of working as a contractor without taking any of the risks that come with working independently. If your contract is deemed to be caught by the legislation or inside IR35 then you will still be able to complete the contract, but you will not be entitled to the same tax benefits as contractors who are outside IR35 and you will only be able to claim a small range of business costs as expenses. For more information about IR35 and how to determine the IR35 status of your contract you may want to visit our complete guide to IR35.
As a contractor no one is going to be planning for your retirement except you and so it is recommended that you take a proportion of your company’s profits and put it towards a pension. Pension contributions are deducted from your company’s profits pre-tax and so you will receive tax relief on the cost.
Keeping up with government schemes and initiatives could help you to work more tax efficiently. For example, from 6th April 2014 the Employment Allowance came into place allowing limited companies to reduce the amount that they are paying in employer’s National Insurance by up to £5,000 (2022/23). If your employer’s National Insurance comes to less than £5,000 annually, which is usually the case for contractors, you will not have to pay any employer’s National Insurance contributions.
You may think that appointing an accountant is an additional expense that you can do without, but an accountant can actually save you money, time and stress. When you first start out as a contractor you are going to have a lot of questions on everything from what you can claim as an expense to whether the flat rate VAT scheme or the standard VAT scheme will be best for you. If you appoint an accountant they can answer these questions as well as provide additional tax saving advice.
You could go to a traditional high street accountant, but they are unlikely to have a detailed knowledge of the tax and legislation that is specific to contractors such as IR35. Appointing a firm of accountants that specialise in the contractor market means that they will have experience dealing with contractor finances on a daily basis.
If you have a question about any of the tips that we have mentioned in this article, or if you would like more information about contracting in general please get in touch with a member of our new business team on 01253 362062.