IT Contractor Tax - Accountants for Contractors

When you start to contract via your own company, you will be liable for a number of business taxes, in addition to the individual taxes you will already be familiar with when you had a permanent job.

1. Corporation Tax.

All companies pay a tax on their annual profits. Assuming you make under £300,000 in profits, your company will be liable to the 'small profits' tax rate which is currently 20% (2012/13). Larger companies, who generate over £1.5m in annual profits pay the main corporation tax rate of 24%. In between the two thresholds, a system of 'marginal relief' applies.

Your contractor accountant will inform HMRC that your limited company has been formed (unless it is already active and you have paid corporation tax before).

Each year, your accountant will fill in your Corporation Tax return (Form CT600) and submit it online. You must pay the previous year's tax within 9 months of your company year end date.

Limited company contractors who are caught by IR35 will pay themselves a 'deemed salary', comprising most of the company's annual profits, so their Corporation Tax liability will be nil or very small.

Find out more in our Corporation Tax guide.

2. Value Added Tax

Most contractors register for VAT, even if they do not expect to breach the £77,000 turnover threshold in any given 12 month period. Depending on your circumstances, you can register for the standard VAT scheme, or the Flat Rate scheme.

If you don't expect to reclaim large amounts of expenses, you may well be better off by joining the Flat Rate Scheme. Instead of accounting for VAT on each transaction on the standard scheme, you apply a flat percentage to your turnover (14.5% for most contractors). In the first year of joining the scheme, you benefit further from a 1% discount to the flat rate - to 13.5%.

Each quarter, you (or your accountant) will complete a VAT return, and submit it together with payment within one month of the end of the quarterly period.

Find out more about accounting for VAT.

3. Employers' National Insurance

Limited companies pay Class 1 NICs on the salaries paid to their employees. As your 'employer', your company will therefore be liable to pay 13.8% on the salary you draw above £144 per week (2012/13).


4. Employees' National Insurance

Employees (including limited company directors) also pay Class 1 NICs on their earnings. The rates are 12% between £146 and £817 per week, and 2% on earnings above £817 per week.

Read more in out guide to National Insurance.

5. Income Tax

Any salary you draw as a limited company director is subject to standard PAYE (Pay as your Earn) taxation.

You will pay income tax on any income received above the personal allowance threshold (currently £8,105 in 2012/13), according to the tax bands you cover (at 20% - basic rate, 40% - higher rate and 50% - additional rate).

If you earn above £100,000, the value of the personal allowance is removed by £1 for every £2 over this threshold.

6. Dividend Tax

Assuming you are not caught by IR35, you will draw most of the profit from your company in the form of dividends.

Dividends are taxed at three rates - 10%, 32.5% and 42.5% depending on the amounts involved. However, to account for the tax that Corporation Tax has already been paid on the company's profits, a 10% tax credit is applied to all dividends, which means that the effective tax rates are actually 0% (basic rate), 25% (higher rate), and 36.1% (additional rate).

Read more about how dividends are taxed.

7. Other Taxes

Other taxes you may come across while contracting include Capital Gains Tax (if you realise a profit on any investments, including if you sell your company at some time in the future).