How to become an IT Contractor

Aside from umbrella schemes, and direct PAYE via recruitment agencies, most IT contractors trade via their own limited liability companies. This is the most tax efficient way of contracting, but there are several key points to consider before deciding if this is the right trading structure for you.

Contracting via a limited company

As the name suggests, as a limited liability company director, you have no personal financial liability if the company fails. You and your company are two distinct entities. Your company will invoice your agency/client for work performed, not you personally.

All companies are registered at Companies House, and you will need to oversee various administrative tasks each year to comply with company law. For example, you will need to submit an Annual Return (Form AR01) each year, keep Companies House informed with any changes in the way your company is run, and ensure that your company accounts are submitted accurately and on time.

You will typically use the services of a specialist contractor accountant to take care of all your accountancy requirements - including dealing with tax, VAT, payroll, and taking care of correspondence with HMRC.

As a limited company director, you are ultimately responsible for meeting statutory deadlines and ensuring the accuracy of your accounts, but your accountant will essentially take away most of the 'hassles' commonly associated with running a limited company.

Tax considerations

If your contract falls outside the IR35 rules, you will be subject to normal corporation and personal tax rules.

Firstly, your company will be subjected to corporation tax of 20% on your profits (the 'small profits tax rate').

Secondly, depending on the size of your salary (usually fairly small), your accountant will deduct any PAYE and National Insurance liabilities at source. You will draw your net salary at agreed intervals (monthly, quarterly, etc.)

You will withdraw the remainder of your income in the form of company dividends, which is the most tax efficient way of withdrawing funds from the company.

You will pay any further personal tax on your dividend and other income via the self assessment system each year. The annual deadline for payment and submission of online tax returns is 31st January.

Is going limited right for you?

Despite being the most tax efficient way of trading for IT contractors, deciding whether to contract via a limited or umbrella company should be more than simply a financial decision.

If your contract is caught by the IR35 legislation, for example, the tax benefits of contracting via a limited company are greatly reduced. However, there are still some benefits to contracting via a limited company even if your contracts fall inside the IR35 rules (e.g. benefits of using the Flat Rate VAT scheme if appropriate, and the 5% "expenses allowance").

If you're happy taking on the extra responsibilities and freedoms that becoming a company director involves, working via a ltd company is probably best for you.

If you want an entirely 'hassle-free' life, are working on very short-term contracts, or feel that IR35 has removed most of the point of trading via a limited company, then a PAYE umbrella company is most likely to suit you.

Read more in our limited or umbrella? guide.

In either case, you should always consult a contractor accountant who can work out what's best based on your personal situation.

Setting up a limited company

Forming a new company is an easy process. You can set up a limited company online in minutes, or hire contractor accountant who will do this for you.

You can buy an 'off the shelf' limited companies for as little as £30 which would include PDF documentation.

An accountant may provide this service for free if you hire them, or charge around £120 as an 'extra'.