Contracting through a Limited Company / Personal Service Company
So, you’re thinking about using a limited company to contract through? Read our short guide below to find out a little more about limited companies and what is required in the setting up and running of them.
1. What is a limited company?
The term limited refers to the fact that the company’s finances are separate from the personal finances of the owners. Shareholders have ‘limited liability’ which means they are liable only for the amount that they have invested in the company and are not responsible for company debts. However, they may be asked to guarantee loans or credit granted to the company.
As a limited company there are a number of requirements that have to be fulfilled:
- The Company must be registered at Companies House.
- Annual Accounts must be filed at Companies House.
- Annual Returns must be submitted each year to Companies House.
- HMRC must be informed of the Company's profits each year.
- Company must complete an annual Inland Revenue corporation tax return and pay the due taxes within nine months of the Company year end.
- Anyone employed by the Company must pay income tax and national insurance on their salary.
2. How do I set up a limited company?
With our 'Freestyle Contractor' service you don’t need to worry, we will take care of everything for you from setting up your limited company and registering for VAT right through to setting up a business bank account for you and sending out (and chasing) your invoices.
For those contractors who intend to set up their own Limited Company or use a different accountancy practice, we have included the following basic guide outlining the requirements for registering your limited company.
Registering your Limited Company.
Before your business can set up as a limited company (or become “incorporated”) it needs to be registered with Companies House.
You will need to complete the following documents and return them to Companies House to complete the incorporation process:
- Memorandum of Association – includes information on Company Name, Location and Type of Business.
- Articles of Association – Outlines Director’s power, shareholders rights etc
- Form 10 – Provides details of the Directors’ and Company Secretary’s Name and Addresses, together with the Registered Company address,
- Form 12 – Simply states that the Company complies with the terms of the Companies Act.
These documents are normally prepared by accountants or formation agents; however there is no legal requirement to use either. Guidance on all aspects of the registration process, including documentation required to complete the registration process can be found at the Companies House website.
3. How do I pay myself through a limited company?
The way in which you pay yourself through a limited company depends on the IR35 status of the individual contract you are working on.
If your contract is outside IR35…
Provided your contract is outside IR35 then the most tax efficient way to pay yourself will be to take the traditional route of a low salary (subject to income tax and national insurance) combined with high dividends.
As dividends are provided with a “tax credit” there is no additional tax to pay unless your total income (salary + dividends + interest etc) exceeds the basic rate threshold.
What are dividends?
Dividends are a distribution of the company’s ‘after-tax profits’ to the shareholders of a limited company. Any limited company which has generated profits can pay a dividend to its shareholders.
After tax profits = Total income / revenue – Expenses (includes your minimal salary) – Company Taxes.
By taking a minimal salary each month you will ensure that the company generates after tax profits (as your income will be greater than your outgoings), at which point you can then pay yourself a dividend.
It is necessary to complete a dividend declaration form each time a dividend is declared. Under the 'Freestyle Contractor' service this will be done for you free of charge.
If your contract is inside IR35…
Unfortunately, if your contract is caught by IR35 then all income will be subject to tax and national insurance, regardless of whether it is paid through salary or dividends.
PAYE Payroll
PAYE is “pay as you earn” income tax that has to be deducted from your salary before it is paid to you. As part of the 'Freestyle Contractor' service we will register your company for PAYE and undertake all the necessary administration for you, such as keeping payroll records and paying PAYE and national insurance every month, together with submitting all year end forms to HMRC.
4. Claiming Expenses through your Limited Company?
The expenses you are allowed to claim through your Limited Company are dependent on the IR35 status of your contract.
Provided your contract is outside IR35 then the following expenses can be claimed:
- Your gross salary – this would usually be kept low, in order to maximise dividends payable to yourself as shareholder (thereby avoiding employees and employers national insurance contributions).
- Spouse’s salary (which must be actually paid and not unrealistic, having regard to the duties performed). If your spouse is already employed and earning £40,000 or more, then there is unlikely to be any tax saving in paying them.
- Travel expenses. (Not generally possible once you have been or know you will be at your client site for more than 2 years.)
- Car mileage. (Not generally possible once you have been or know you will be at your client site for more than 2 years.)
- Accommodation and subsistence. (Not generally possible once you have been or know you will be at your client site for more than 2 years.)
- Telephone - business calls only.
- Books, magazines, subscriptions and courses – where related to business and your contract work.
- Bank charges and interest – on your company bank account.
- Pension scheme – where paid by the company to a HMRC approved scheme.
- Business insurances, business contents and other business related insurances.
- Computer costs.
- Accountancy fees.
- Business related stationery and postage costs.
All of the above expenses should be supported by a valid receipt or document, with the exception of salary and car mileage.
However, if your contract is caught by IR35 then you can only claim expenses incurred wholly, exclusively and necessarily in the performance of your contract work together with a 5% “administration allowance”. These are as follows:
- 5% administration allowance (5% of gross fees received)
- Travel expenses
- Accommodation expenses
- Pension contributions
- Certain professional subscriptions
5. Do I need to be registered for Value Added Tax (VAT)?
Value Added Tax (VAT)
Value added tax (VAT) is a tax on consumer expenditure. It is collected on business transactions, imports and acquisitions, and is administered by H.M. Revenue & Customs.
If your company’s taxable supplies (the supply of any goods and services which are subject to VAT at any rate) are likely to exceed £64,000 in the next 12 months then you will need to register for VAT. Once your company is Vat registered you will need to charge VAT on your invoices at the standard rate of 17.5%. Until then you can simply raise sales invoices without adding VAT.
What are the benefits of VAT registration?
Once your company is registered you will be able to recover any VAT that you incur on items that you buy for the business. You can usually claim VAT on the following:
- Computer equipment and software
- Stationary
- Accountancy fees
- Legal fees
- Telephone
- Petrol and motor repairs (if claiming a mileage allowance the VAT element is 1p a mile)
- 50% of the VAT paid on either the car lease rental payments or car contract hire payments.
What are the disadvantages of VAT registration?
The drawback to being VAT registered is that you are required to complete quarterly VAT returns and submit them to H.M. Customs & Excise. Most companies will employ an accountant to complete their VAT returns.
Our 'Freestyle Contractor' option is an all-inclusive service that includes quarterly VAT returns as part of the fixed monthly fee.
VAT - A few things to remember…
VAT payable must be paid by the last day of the month following the VAT quarter. Failure to pay on time can result in penalties and is likely to increase the chances of your company being selected for a VAT inspection.
IMPORTANT: In order to recover VAT on items that you buy for the business you need to obtain a “VAT invoice”, which shows the suppliers VAT number. Remember to always ask for a VAT invoice as these are not normally provided as standard.
6. Limited Company and Corporation Tax
Corporation tax is tax on your companies’ taxable income or profits. For small companies with annual profits not exceeding £300,000, the rate of corporation tax is 20% (this is called the small companies rate). Any companies with profits in excess of £300,000 will be liable for 30%, subject to marginal rate relief.
Companies are required to work out their own corporation tax and are required to deliver a corporation tax return by the statutory filing date, normally 12 months after the end of the accounting period. Failure to do so can result in the company receiving a penalty.
The corporation tax return is another service that is included in the fixed monthly fee for our Freestyle Contractor Limited Company service.
7. Timesheets and Invoices
As with all contractors you will need to record your time on a timesheet so that your agency or client can approve the hours / days that you have worked in a certain billing period. In addition, you will need to ensure that an invoice is raised and submitted to your agency / client for your time.
Many companies now provide online timesheet systems where you can login and record your hours electronically.
Our 'Freestyle Contractor' service takes this a step further. First you record your hours worked via our online timesheet system and then at the end of a billing period (week / month) an invoice is automatically generated, which you can then review before submitting to your agency or client. Agency / client invoices can be delivered by email, fax or post, or a combination of these methods.
Hopefully this brief guide has given you more of an insight into what's involved in contracting through a limited company. Should you be interested in our all-inclusive limited company accountancy service or simply have some questions you would like answered please contact us on 0870 850 0887 or email tax@freestyleaccounting.com.