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.
This article has been updated for the 2020/21 tax year.
1. Corporation Tax.
All companies pay a tax on their annual profits. In previous years, there was a separate ‘small profits’ corporate tax rates, however, all companies now may the same rate of Corporation Tax.
The current Corporation Tax rate is 19%.
Your 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 £85,000 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%.
It is worth noting that, from April 2017, companies with very few expenses (‘limited cost traders’) have to pay a higher 16.5% rate, making the Flat Rate scheme unattractive by those affected.
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 at or above £169 per week (£8,788 per year).
If your company meets various requirements (it must not have a sole director-employee), then you can reclaim up to £4,000 of Employers’ NICs each year, thanks to the Employment Allowance. However, as many professional contractors draw down low salaries, many are unlikely to have much to reclaim.
4. Employees’ National Insurance
Employees (including limited company directors) also pay Class 1 NICs on their earnings. The rates are 12% between £183 and £962 per week, and 2% on earnings above £962 per week (£9,500 to £50,000 per year).
Read more in our 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 (£12,500 in 2020/21), according to the tax bands you cover (at 20% – basic rate, 40% – higher rate and 45% – additional rate).
The higher rate tax band threshold is £37,500, so you will enter the higher rate band when you earn more than the £12,500 personal allowance plus £37,500 = £50,000.
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.
The way dividends are taxed was changed significantly in April 2016, and almost all contractors have had to absorb a tax hike to some degree.
The first £2,000 are dividends are in a ‘nil band’ for tax purposes, although they do still form part of your overall tax allowances. This allowance was reduced from £5,000 to £2,000 from April 2018.
Dividend income is then taxed at three rates – 7.5% (basic), 32,5% (higher) and 38.1% (additional). Any tax due is payable by the annual self-assessment process.
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).