Introduction -tax tips when you are contracting
Small business tax tips for UK contractors. This is an informative article that contains many accounts and tax tips. These tips are mainly for contractors who are working through a limited company. However, many of the tips apply to other business owners too.
When you are employed full time or work through an umbrella company, your employment status is that of a PAYE employee. Under this scenario, the administration and financial side are taken care of by your employer. On the other hand, when you are a business owner you are in control of the administration and finances. Along with this, comes the opportunity to make savings that are not available when you are employed.
When you are an individual, you can look to make personal savings wherever they are available. Likewise, when you are running a business, you can also look to make savings. These savings will come by way of claiming for all legitimate expenses. As a result, this will help reduce the overall tax bill for the business.
Much of this contractor tax planning advice also applies to directors of UK small companies in general too. There are many aspects that also apply to sole traders and partnerships. We will demonstrate the many ways that your business can save tax and operate tax efficiently. Just like making personal savings as an individual, you can also make business savings when you take the time to consider how to run your business tax efficiently.
When you are an independent contractor or small UK business owner, work can be a challenge each day. This can also add to the stresses when you are already running a busy life, outside of work.
This guide can be handy and the contracting advice below shows how you can work and operate on an efficient basis. You can take these on board when you are running your own company. When you utilise the ideas below, it will stand you in good stead going forward. The end result will also help you save tax along the way.
There are all sorts of contracting industries and these include:
This small business tax tips guide is suitable for all contractors and small business owners with their own company.
We also have a first timer’s guide to contracting in the UK. This gives a full overview of what to consider, when you start out for the first time going contracting. Besides planning ahead, there are many things to think about when you start your business. This includes business banking and choosing an accountant. It also includes deciding on your accounting system, keeping accurate records and many more considerations.
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 the tax year 2022/23, every individual has a tax-free 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.
If you earn more than this you will fall into the higher or additional rate of tax. You will be a higher rate taxpayer if your income falls between £50,271 and £150,000, Alternatively, if you earn over £150,000, you will fall into the tax bracket of additional rate taxpayers.
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 take now in 22/23 is £992.33 per month if you have no other income that will use up your personal allowance. Such other income would include rental profits, self-employment profits, pension income etc. If you do have other income, £823 will be the optimal salary instead.
Individuals should aim to attain 35 `qualifying years’ during their working life. When they do this they qualify for the full UK state pension when they retire.
Dividends that fall within your basic tax rate are taxable at 8.75%.
Tax efficiency considerations
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. You can do this 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 to the following year. It is then available to be paid in the future.
Another important point is company income is not taxed twice. It 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. This additional tax will depend on how high the borrowing is and how long it is left owing for.
5 Small business tax advice -VAT
VAT sub scheme
Another one of the important small business tax tips is which VAT scheme you use. Nowadays, most contractors can save tax by operating under the `normal’ VAT scheme. This is also known as the standard 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 consultancy fees that you charge. This % is comparable to the usual 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.
Cash or invoice basis
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.
Operating on a cash basis this means that you pay over the VAT that you invoice to your customers once it is received. In addition, you can only reclaim VAT on the invoices from suppliers when you have paid them.
Therefore, reporting your VAT on a cash basis helps improve your company’s cash flow.
Making Tax Digital
Another consideration is businesses that are registered for VAT also now need to comply with MTD. This stands for Making Tax Digital.
Small business tax advice UK -further considerations
6 Save tax by claiming tax relief on all genuine business expenses
Here we look at another one of the key tax tips for UK contractors and small business owners. This tip is to ensure that 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. It will do this after it completes and files its future company tax returns.
Therefore, please make sure that you obtain a receipt for any business expenses that you incur. Your company can then repay these expenses to you. Indeed, some contractors and business owners do not do this. It is important that you do this, otherwise you are paying for these out of your own post-tax income.
Besides the usual business trading expenses, where you meet certain criteria, you can also claim for:
In addition, and again after meeting certain criteria, you may be able to claim for:
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). The receipts are the proof that you have incurred the expenses.
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. When you do this you can claim for mileage at HMRC’s allowed rates.
Most vehicles, if you run them through your company, will cost a fair amount in tax. This tax is 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.
However nowadays, if you have a hybrid or electric vehicle, you may be better off running a company car. There are currently some good 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. This could include dealing with e-mails and answering phone calls. They could also be opening the post 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. This is because 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 will benefit from this if you fall into one of the scenarios.
9 Tax tips for small business owners -stay informed of your company’s ongoing financial position
Here is another of our very important tax tips for UK contractors and small business owners. 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 the bank balance 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 accounting software 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 for 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
This is one of the less well-known small business tax tips for you as a contractor. Every year, your company can pay you and any of your employees `trivial benefits’.
Individual amounts that are paid 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). When the payment is to an individual who is a director or other office holder or a member (shareholder) this includes 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 phone 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 an 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 make pension contributions into a company pension scheme, this is a tax-deductible expense. As a result, 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 industry. We detail here the things to consider, if you are thinking of changing your accountant.
17 You can save tax and make other savings 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. When you purchase any financial products, the provider should be regulated by the Financial Conduct Authority.
Relevant Life Insurance (RLI) is not the same as standard life insurance. If you take RLIs 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. They offer both of the above products and have helped many of the websites’ members. If you are interested, there are forms that you can complete at the bottom of these articles. These articles can be found on the finances page.
Individual tax tip
As briefly mentioned earlier and although this not beneficial to everyone, you could check to see if you can claim for the UK marriage allowance. This is available to those who have a spouse and this includes civil partners.
It is beneficial to claim for this when one partner has income within the basic rate tax band (income up to £50,270 pa), whilst the other partner is not using up all of their personal tax allowance (this is currently £12,570 pa).
The ideas shown here in this small business tax tips guide will go a long way to help you to 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