Introduction -tax tips when you are contracting
Small business tax tips for UK contractors -this is an informative read for contractors who are working through a limited company.
Much of this contractor tax planning advice also applies to directors of UK small companies in general too, as well as sole traders and partnerships. We will demonstrate the many ways that your business can save tax and operate tax efficiently.
When you are an independent contractor or small UK business owner, lit can be a challenge each day when you are running a busy life. This guide can be handy, and the contracting advice below shows how you can work and operate on an efficient basis, when you are running your own company. When you utilise the ideas below, it will stand you in good stead going forward and also help you save tax along the way.
There are all sorts of contracting industries and these include IT contracting, management contracting, mechanical contracting, engineering contracting and many more. This small business tax tips guide is suitable for all contractors and also small business owners with their own company in general.
We also have a first timer’s guide to contracting in the UK. This which gives a full overview of what to consider, when you start out for the first time going contracting.
Small business tax tips -contracting advice that covers salary, dividends, and tax allowances
1 Save tax by paying yourself a tax-efficient mix of dividends and salary
When you are a director of your own company, you can choose what salary to pay yourself.
In 2022/23, every individual has a personal allowance of £12,570. You also have a dividend allowance of £2,000. Both of these allowances fall within the amount of income that is taxable at Basic Rate tax. In 2022/23, this is gross income up to £50,270.
A gross salary of £823 per month equates to £9,880 per annum. This level of pay is enough to count as a `qualifying year’ for state pension purposes. An optimal salary to now take in 22/23 is £992.33 per month if you have no other income such as rental profits, self employment profits, pension income etc that will use up your personal allowance. If you do have other income then £823 will be the optimal salary.
Individuals now need to attain 35 `qualifying years’ during their working life to qualify for the full UK state pension when they retire.
Dividends that fall within your basic tax rate are taxable at 8.75%.
To be tax-efficient, you may decide to take a gross salary of £11,908 per annum (£992.33 per month) or £9,880 per annum (£823 per month). You can then take the rest of your income as dividends.
If you are earning enough to take a gross income of £50,270 from your company, and your only income is salary and dividend, the tax payable under the above example via your Self -Assessment Tax Return would be £3,124.
If you do have other income, you would need to look at your overall picture by taking all of your other income into account.
You can discuss this with your accountant and decide what is the most tax-efficient mix of salary and dividends.
2 Minimise your National Insurance (NI) contributions
Salaries incur National Insurance, and the higher your salary is, the more NI you and your company will pay. If you decide to pay yourself on a tax-efficient basis and take a salary as in the example in the above point, you will minimise the NI that you incur. As a result, you can then take the rest of your income as dividends.
3 Being aware of how your tax bands and allowances work
This is one of the important small business tax tips to consider, therefore please take note. You do not need to take all of the dividends that are available in the year that you earn them. The profit in a company is taxable in the year that the business earns it. Any post-tax income that you do not pay as dividends is carried forward and is payable in a future year. Finally, company income is not taxed twice and is only taxable in the year that the business earns it.
If you draw out all of the dividends available, you may incur higher rates tax. The rates that are payable if you do, are 33.75% on gross income above £50,270 and 39.35% on gross income above £150,000.
4 Contracting advice -do not draw more dividends than you are legally allowed to take
When you run your own company, the business, just like you, has its own tax bills. UK companies pay Corporation Tax (CT). Your business also has other taxes which are:
- PAYE and National Insurance contributions, if you run a PAYE scheme
You should also make sure that you only draw out amounts as dividends, after allowing for your company’s tax bills.
If you draw out more than is allowed, the surplus drawings over profit are illegal dividends. As a consequence, your dividends would then need to be restricted. In turn, this would create an overdrawn director’s loan account. This loan can then result in extra tax to pay, depending on how high the borrowing is and how long it is left owing.
5 Small business tax advice -VAT
Another one of the important small business tax tips to note, is you can save tax by operating under the `normal’ VAT scheme.
In recent times, the VAT Flat Rate scheme (FRS) was more tax advantageous. However, the government changed the rules in April 2017. Under FRS, most contractors now pay over a rate of 16.5% Flat Rate VAT on their gross income. The result of this equates to an actual VAT rate of 19.8% on the net. This % is comparable to 20% VAT that they charge -an actual saving of £20 per £10,000 that is invoiced.
If you operate under the standard / normal VAT scheme, you can reclaim the VAT within your expenses on your VAT returns. For most contractors, this should not be a complicated job. This does however involve a little bit more work, when you operate under the standard VAT scheme. However, you will save tax or you will be quite a bit better off when you operate under this scheme.
Also, a business can report its VAT on a cash basis or invoice basis however you are only compelled to comply with the latter if you are a large business. Therefore, reporting your VAT on a cash basis (this means that it is reported once received or paid as opposed to invoiced) helps improve your company’s cash flow.
Businesses that are registered for VAT will also now need to comply with Making Tax Digital (MTD).
Small business tax advice UK -further considerations
6 Save tax by claiming tax relief on all genuine business expenses
One of the key tax tips for UK contractors and small business owners, is that you ensure you claim for all of the business expenses that you are legally allowed to. In turn, this will help minimise how much Corporation Tax your company pays, when it completes and files its future company tax returns.
Please make sure that you pick up any business expenses that you incur. Your company can then repay these to you. Indeed, some contractors and business owners do not do this. It is important that you do, otherwise you are paying for these out of your post-tax income.
Besides the usual business trading expenses, where you meet certain criteria, you can also claim for home office, professional subscriptions and company donations. In addition, and again after meeting certain criteria, you may be able to claim for business clothing and business gifts.
With all business expenses, you should ensure that you collect and save receipts. This can be either a paper receipt or an electronic one (or a mix of these methods), and they are proof that you incur each expense.
7 Company car or private car when you are contracting?
In most cases, you are more tax-efficient to keep your car as a private vehicle and claim for mileage at HMRC’s allowed rates.
Most vehicles, if you run them through your company, will cost a fair amount in tax upon the benefits in kind that are applied to a company car. These are usually more than the CT that your company will save on the car cost and running costs.
Nowadays, if you have a hybrid or electric vehicle, you may be better off running a company car. There are tax breaks for hybrid vehicles. Therefore, it’s certainly worth considering one of these vehicles, if you plan to run a company car through your business.
8 If your spouse or partner is doing work for your business, pay them a salary
Another one of the small business tax tips to consider is paying your spouse a salary. Indeed, your company can pay your partner a salary if they are doing some work for your company. Your spouse may be doing administration type jobs, including dealing with e-mails. They could also be opening the post, answering phone calls and updating your accounting system, etc.
When your company pays a salary to your spouse or partner, their wage will reduce the amount of company profit that is subject to CT.
Before you consider the above, you ought to consider what their other income is as a salary from your company could affect their overall tax bill.
As part of your personal tax return preparation, and on an ongoing basis where appropriate, you could consider making use of the transfer of the marriage allowance. This is only beneficial in certain scenarios however you could benefit from this.
9 Tax tips for small business owners -stay informed of your company’s ongoing financial position
One of our very important tax tips for UK contractors and small business owners, is once you have taken your salary and dividends, reimbursed any expenses, and paid any other bills, you will have a balance left in your company bank account(s). You will need to know how much of this to save for company taxes and other bills. After taking all of this into account, you should be able to work out how much of the balance is still is available for you.
Most online systems, and this includes FreeAgent, will provide this information for you at a glance.
Small business tax tips -tax deductible expenses and the rules around these
10 Make sure you do not fall foul of the 24 month rule for travelling expenses
As a contractor, you can claim your travel expenses to and from work and to and from other work sites. However, you need to be aware of the 24 month rule. This rule states that as soon as you know, you will be at a worksite (that you spend 40% of your working time or more at) for longer than 24 months, you can no longer claim expenses to that site.
Being able to claim your travel expenses can have a significant effect on your net income. The higher the cost of your travel expenses, the more significant the impact will be if this affects you.
11 Small business tax advice -save tax by making sure you hold your `annual event’
Every year, you can claim for up to £150 per employee in respect of an `annual event’ or `events’.
This event could be the annual Christmas party, or a series of events during the year.
The party is fully tax-deductible, providing that the amount does not exceed £150 per employee.
12 Tax tips for small business owners -save tax by claiming for trivial benefits
One of the less well-known small business tax tips for you as a contractor, is that your company can pay you and any of your employees `trivial benefits’.
Individual amounts for trivial benefits must not exceed £50, including VAT.
There is a total cap of £300 per annum, if the employer is a `close company’ (companies with less than five shareholders). The payment is to an individual who is a director or other office holder, or a member of their family or household.
13 Save tax by claiming for your mobile phone bills through your business
If you use your mobile phone for work reasons and there is only a `token’ element of personal usage, you can claim for your mobile costs as a business expense.
When you claim for your mobile phone costs, you should try and ensure that the bills and account are in your company’s name.
14 Make sure that you claim for use of home as office
The government increased the amount that you can claim for working from home to £6 per week on 6 April 2020. You can claim for this, and perhaps more if you do a lot of work from home.
If you actually have your own office that is separate to your home address, you can claim for the rent, business rates, utility costs and any service charges.
15 Contracting advice -consider paying into a company pension scheme
If you pay into a company pension scheme, this is a tax-deductible expense and it will save your company CT.
When you pay into a pension scheme through your company, this is also a way of extracting further funds from your company, without incurring higher rates tax.
16 Small business tax tips -other areas to think about
It is a good idea to Invest in a good accountant that specialises in the contracting area. We detail here the things to consider, if you are thinking of changing your accountant.
17 You can save tax with other financial products
When you are a contractor, you will lose certain benefits that you receive as an employee. Therefore, it may be worth thinking about any relevant financial products for your protection in the future.
Relevant Life Insurance is not the same as standard life insurance. If you take this out, it is tax-deductible through your company. This also works out much less expensive when you pay for it through your company, over the term of the policy.
Secondly, as a contractor, if you are unable to work, you will no longer be able to claim for statutory sick pay. Therefore, Income Protection will provide you with an added piece of mind, should you be unable to work in the future. A valued partner of Contractor Advice UK are Broadbench and they offer a great service here.
The ideas shown here in this small business tax tips guide can go a long way in helping you save tax as a UK contractor or small business. We do not cover absolutely everything here however many of the tips above will help you to reduce your overall tax calculation as a UK contractor or small UK business.
Link to Contractor Advice UK group on