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 (the owners) have ‘limited liability’ which means they are liable only for the amount they have invested in the company and are not personally responsible for company debts.
What are the Benefits for Contractors?
- Operating through a Limited Company is a far more tax-efficient option; through a combination of low salary and high dividends contractors can reduce their tax and national insurance liabilities.
- The Limited company’s finances are separate from the individual’s finances.
- Clients and agencies often do not want to engage an individual contractor directly; instead they prefer to engage a limited company which essentially acts as an intermediary.
- Contractors are able to claim legitimate business expenses
10 Things You Need to Know Before Going Limited
As a Limited Company director you have the following responsibilities to perform. You must decide whether to do this yourself (do you have the time and knowledge?) or hire an accountant to perform them for you.
|Responsibilities||Can it be done by your accountant?|
|Register your company at Companies House||YES|
|Annual Accounts must be filed at Companies House||YES|
|Annual Return must be filed at Companies House||YES|
|HMRC must be informed of the Company’s profit each year||YES|
|Complete a HMRC Corporation Tax return each year||YES|
|Any employees must pay income tax and national insurance||YES|
Setting up a Business Bank Account
As the finances of your limited company need to be separate from your own personal funds, you’ll need to arrange a bank account for the business.
IR35 – What is it and Does it Affect You?
The IR35 legislation seeks to determine what the working relationship would be if you were engaged directly by your End Client; in short it asks the question – are you an employee “disguised” behind your limited company?
Inside IR35 – If you (the employee) are provided by your limited company to an ultimate client on contract terms which would normally constitute employment with that client, then this is called a ‘relevant engagement’ and the IR35 rules apply. In this situation (where your contract is ‘inside IR35’) the concept of “deemed salary” is introduced and any income from that contract will be subject to tax and national insurance contributions, as if it had been paid as a salary.
Inside or Outside IR35?
The tax advantages of your own Limited Company are wholly dependent on whether your contract falls inside or outside the IR35 “rules”. Contractors who fall outside the IR35 rules will be better off operating through a limited company, whereas those inside IR35 may find that an umbrella company payroll solution is a more suitable option.
How to Pay Yourself
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 PAYE income tax and national insurance) combined with high dividends.
What are dividends?
Dividends are a distribution of the company’s ‘after-tax profits’ to the shareholder(s) of a limited company. Any limited company which has generated profits can pay a dividend to its shareholders.
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.
Professional Indemnity Insurance
As an independent contractor you will be providing your services as well as professional advice to clients. In the event that you make mistakes or errors while contracting for a client, they are perfectly within their rights to claim for negligence. For this reason many clients will insist that you are covered by appropriate insurance before they will hire you.
Professional Indemnity Insurance
Professional Indemnity insurance (PI insurance) protects contractors against claims for negligence, loss of data or documents, unintentional breaches of intellectual property and claims for dishonesty.
As the risks faced by individual contractors will depend on their area of expertise, specialist insurers will provide professional indemnity policies that are tailor made to the contractor’s area of expertise.
Provided your contract is outside IR35 then the following expenses can be claimed:
- Your gross salary
- Spouse’s salary
- Travel expenses / Car mileage
- Accommodation and subsistence
- Telephone – business calls only
- Books, magazines, subscriptions and courses (related to business and your contract work)
- Bank charges and interest (company bank account only)
- 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 expenses should be supported by a valid receipt or document, with the exception of salary and car mileage.
Specialist VAT Scheme for Contractors
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 £85,000 in a 12 month period then you will need to register for VAT.
Fortunately, a specialist VAT scheme is available that reduces the administration burden on small contractor businesses. It allows companies with up to £150,000 turnover to work out the net VAT due to Customs by recording their tax inclusive turnover and applying the appropriate percentage for their trade sector to total income.
This specialist VAT scheme often works in the contractors favour as they add VAT on their invoices at the standard 20% but end up paying a lower percentage (i.e. 12% in some sectors) to HMRC.
Invoicing your Clients and Bookkeeping
Once you have setup your Limited Company you’ll need to start invoicing your client or agency for work completed. In order for your accountant to prepare annual accounts and quarterly VAT returns you will need to keep a record of all invoices and expenses for the business.
Some accountants will provide a spreadsheet template for you to manually keep a record of all invoices and expenses, but this can get messy and laborious. Many accountants now provide you with your own online Bookkeeping Portal on which to record all your invoices and expenses. These systems will often provide you with a live financial position of your company as well.
Your Personal Tax Return
Once you start contracting through a Limited Company, you will be required to submit a Personal Tax Return to HMRC, detailing your income for each financial year. Most accountants will prepare your annual tax return for a set fee of around £300 + VAT.
Hiring an Accountant
No doubt as a busy contractor, you’ll probably want to hire an accountant to help with your Limited Company, rather than trying to do the work yourself. There are lots of options –specialist contractor accountants, small local accountants and lots of online accountancy providers. Before making a decision you should ask yourself (and them) the following questions:
- Are they Chartered Accountants regulated by a professional body (does their website display the ACCA or ICAEW logo)?
- Are they accredited by the Association of Independent Professionals and the Self Employed (IPSE)?
- Will a Chartered Accountant be checking everything for accuracy or is it just accountancy software they are providing? (this can be very costly if mistakes are not found!)
- Do they have sufficient knowledge of and expertise in the contracting industry, or are their clients mainly local businesses?
- Is their service very cheap? Does it seem too good to be true? (trust your instincts)
- Are there any tie-in periods or closing down penalties?