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Q&A – Tax Planning for Contractors

Tax is something that most salaried employees have little, if any, direct involvement with and the need to be aware of and calculate it is often the main thing that intimidates those who are thinking about making the move into contracting.

If you’ve got questions relating to taxation, then read on for a guide to the taxes applicable to contractors and the options open to them to help dealing with the associated concerns.

Do I have to pay tax if I set up a limited company?

Contractors who set up limited companies can legally reduce the amount of tax and National Insurance contributions they are required to make.

This is because it enables you, as a director of the company, to decide your own salary. For example, the optimal salary in the 2012/13 financial year was £8,105 – which equated to £675 per month.

Such a total fell under the individual level of personal allowance for income tax during that year and only minimal National Insurance was levied.

Any additional money that you earn through contracts can then be held within the company and withdrawn as dividends, which attract a much lower rate of tax and no deduction for National Insurance.

Can anyone set up a limited company?

The process of setting up a limited company is actually quite simple and can be done quickly and easily. However, the levels of administration involved with operating in this manner – such as invoicing, calculating expenses, completing tax returns (more information can be found here) – mean you should consider whether this is the best method for you.

Another key factor is a piece of legislation known as IR35. This prevents you from working as a limited company contractor if a client dictates when, where and how you complete your contract.

The ruling was introduced to prevent salaried employees being listed as directors to limit their tax and National Insurance contributions. If you are deemed to be inside IR35, HM Revenue and Customs (HMRC) will not consider you to be self-employed. In such cases, contractors should look to utilise the services of an umbrella company.

If you are in control of when, where and how you complete your contracts, it is highly likely you will be considered to be outside of IR35 and will be free to operate as a limited company contractor. However, each situation is considered by HMRC on a case-by-case basis, so it is difficult to know for certain how your IR35 status will be deemed. A credible accountancy service provider will offer an IR35 review of your contract if you are in doubt of your IR35 status.

Can I get any help with planning my tax as a limited company?

There are a number of firms that will be able to offer tax advice and compliance services, which will aim to reduce the stress for you when operating as a limited company.

In addition to helping you deal with any investigations by HMRC and the completion of tax returns, these companies will also be able to advise you on the best long-term planning of tax for the company and your personal situation.

For example, should you wish to make an investment through your company, extend your shareholding or explore additional reductions and reliefs, these are all areas in which you will be given expert advice tailored to your specific situation.