A limited company is a private company whereby the owners are legally responsible for its debts but only up to the limit of investment put into the company. If you are heading into contracting with a strong desire for increasing your take home pay or to be a director of a business, this is probably the one for you.
By trading as a limited company, you have complete control over everything including your finances and operations, your personal finances are not at risk should a problem occur with the business, and it allows a highly tax efficient manner of operating which in turn provides the greatest possible take home pay (assuming you fall outside the IR35 legislation which we will go over in more depth later).
This trading style also comes with the most responsibilities and administration, plus you will have to take into account the dreaded IR35 legislation which may affect the financial benefits of this particular trading style.
As a limited company director, you would be responsible for registering tax on your company income and ensuring all payments to HMRC are made on time. Companies incur different taxes to a PAYE employee, so you will need to be aware of them all:
- Corporation Tax – this tax amounts to 20% on profits up to £300,000, and 21% thereafter (although these rates will be unified at 20% as of 1st April 2015). Corporation Tax is owed within 9 months and a day of the company’s incorporation date and a corporation tax return will need to be submitted within 12 months of the end of your company’s Corporation Tax accounting period.
- VAT – companies likely to receive an annual turnover of £81000 or more during a 12 month period must register for VAT. There are two schemes: the ‘cash’ scheme and the Flat Rate VAT scheme of which you will need to discuss with your accountant which is best for you.
- PAYE/NIC – most contractors will still pay themselves a salary on which income tax and Class 1 national insurance contributions are due to HMRC on a monthly or quarterly basis. A personal tax return will need to be completed.
- Dividends Tax – most of a limited company directors income is typically drawn out in the form of dividends after all expenses and liabilities have been taken into account. Although basic rate taxpayers will not pay any tax on their dividends, if you are a higher rate taxpayer, you can expect to pay further tax on your dividend income at a flat rate of 32.5% or 37.5% depending on your tax band, minus a 10% tax credit for already paying corporation tax on the sum.
A Limited Liability Partnership (LLP) is very much the same as a limited company except that it requires two members as opposed to one, and thus gains some flexibility both financially and in work-life balance. When it comes to tax, whereas corporation tax is applicable to a limited company, with an LLP, each member is taxed as an employee of the LLP. IR35 is therefore made irrelevant. Every LLP must have at least two designated members who will be responsible for the filing of company accounts, filing company tax returns and notifying Companies House of any changes. All members, including designated members, are responsible for paying their income tax and NICs as well as sending their personal tax returns.
As the limited company route is far more complicated than the other trading styles, we will be going over in more detail how to start a limited company, the IR35 legislation, contractor insurance and your responsibilities as a director.
With greater flexibility, higher job satisfaction and generally better pay, it is no wonder that so many of us are looking to leave permanent jobs behind and set out on our own.
There are many reasons to start contracting but before you do, firstly consider whether contracting is the right option for you. Contracting can carry with it many benefits, such as being your own boss, providing a more flexible work and personal life balance, higher take home pay, flexible working hours and a variety of tasks, locations and people to keep things from getting too mundane. But it can also come with tasks and responsibilities that not everybody is suited to dealing with, such as administrative burdens, compliance with relevant legislations, tax accountability, responsibility for your own training, marketing requirements to ensure you have work and financial planning to account for time out of work which will no longer be looked after by an employer.
It is important before branching out on your own to assess whether you have the confidence, a realistic approach and, most importantly, motivation needed for a successful contracting career.
All of the above advantages and disadvantages to going contracting are dependent on which trading style you ultimately choose. You will need to spend some time contemplating the different trading styles available to the self-employed worker and choose the best one for you.