The two most common forms of work as a contractor are to operate under the guidance of an Umbrella company or to start a limited company and work for yourself.
Unfortunately (but predictably), those that opt to work under an umbrella company are required to pay a regular fee for the services that the company provides.
A limited company on the other hand, allows you to have full control and full access to your finances at any time with tax being the only third party payment required – unless you decide to hire an accountant.
Tax Advantages of a Limited Company
Whilst a limited company may require a little bit more work and worry for the amount you’re saving by working for yourself, it does also come with tax advantages. This is because limited company contractors generally only withdraw a minor amount as a salary which in turn minimizes the Pay-as-you-earn (PAYE) and National Insurance liabilities. That doesn’t mean limited company contractors only receive a small wage however, as the remainder of the salary is withdrawn from the company not as a wage but as dividends.
The HMRC however call this “disguised employment” and under the IR35 rules they are attempting to ensure that you are taxed at the same rate as self-employed contractors. However, even those that are caught up in these rules may benefit from certain tax advantages such as the 5% expenses allowance. This allowance allows contractors to deduct 5% of their total income at the end of each tax year BEFORE tax and national insurance contributions are paid to cover any administrative costs. This 5% is essentially a tax-free lump sum and regardless of whether you have spent 5% on administrative costs or not, you can claim the full amount (5% of your total earnings before tax) legally.
Other Expenses
As well as the 5% expenses, you can also claim for certain other expenses such as Professional Indemnity Insurance and other similar insurance policies that may be required to successfully complete your job.
You can also claim travel expenses for travel costs that were incurred due to your job although this is tightly watched following recent years of expenses fraud. Pension contributions are also tax free as well as more minimal costs such as subscription to relevant trade publications.
There is an increasing number of contractors using limited companies and whilst it does provide more freedom and more tax advantages, there are also the administrative duties and potential payment-chasing that Umbrella companies often take care of. For this reason it is important that when choosing what structure will best suit you, you take into account both the pros and the cons in relation to your requirements and the various options.