Understanding contractor tax

When contracting via your own limited company there are several things to consider, to ensure 100% compliance with HM Revenue and Customs (HMRC) regulations.

It is very important to have a great understanding of your contractor tax affairs when operating through a limited company, the taxes you pay will arise in two forms, the tax you pay through your limited company and the tax you pay personally.

Taxes you pay personally

Income tax

Income tax is a tax that must be paid on your personal income, this can be income from savings, investments, pensions as well as self-employed work.

As a contractor you will be required to pay tax on your total income, the amount of income tax you pay will be dependant on your personal allowance, the income source and the current tax rates.

National Insurance Contributions (NIC) for Contractors

National Insurance Contribution (NIC) is a payment brought into place by the government in 1911 to act as a safety net to worker when they became ill or unemployed.

Making National Insurance Contributions builds up your entitlement to pensions and state benefits.

Self-employed individuals normally pay Class 2 NIC’s as well as Class 4 NIC’s. However if you are on a low income, you may be exempt from making these payments, you will need to complete  and submit a small earnings form (CF10) form to HMRC to find out if you are eligible  .

See below for the 2013/14 tax year National Insurance Contribution rates

Class 2 National Insurance Contributions

  • Class 2 NIC’s are £2.70 per week

If your profits are less than £5,725 you can elect not to pay National Insurance

Class 4 National Insurance Contributions

Contractors will be required to pay Class 4 National Insurance in addition to Class 2 once their profit reaches £7,755.

  • If your profits are above £7,555 you will be required to pay a contributions of 9%
  • For profits over £41,450, Class 4 contributions are paid at a rate of 2%

There are 2 ways of paying your National Insurance, a payment can be made directly to HMRC or it can be taken through Pay As You earn (PAYE) taxation, which is usually an option if you are paying your contractor tax through a contractor umbrella company.

Capital Gains Tax

If you dispose of your company and make a profit or gain, you may be subject to Capital Gains Tax. It may be possible to reduce your liability through exemptions and reliefs.
See below for the annual exempt amounts (the annual tax free allowance) for 2013/14.

  • Individuals, personal representatives or trustees for disabled people – £10,900
  • Other trustees – £5,450

Taxes paid through your limited company 

Corporation tax

All limited companies are subject to paying corporation tax at a rate which varies between o% and 30%. Most people who operate as a limited company contractor find themselves paying the small companies rate, which is 20% for profits up to £300,000.

Corporation tax needs to be paid within 9 months after the year-end. If your Corporation Tax return is late or has errors, you could be penalised.

HMRC sends out a reminder notice every year for company tax returns, regardless of whether your accountant will be doing the calculations it is important to remain aware of what is going on as you will be penalised if it is filed incorrectly. It is important to make sure all contractor tax affairs are taken care of properly.

VAT (Value Added Tax)

If your company turnover is above £67,000 per year, you must be registered for VAT. This means you will need to charge VAT at a rate of 20% on all invoices to agencies or client.

You will be required to let HMRC know quarterly exactly how much VAT your business has taken in as you will be collecting the money on behalf of HMRC.

You will also be able to claim back money on purchases where VAT has been charged, as long as the goods or service is business related. This will be deducted from the payment you will need to make to HMRC.

Some contractors may be eligible to apply for the flat rate VAT scheme, which can reduce VAT payments, dependent on the circumstances.

To speak to somebody about your contractor tax affairs call us on +44 (0)1923 277 900 or take a look at ourCIS tax solutions.


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