Every day contractors ask us questions about tax and accounts, things to do with their limited company, or just general business questions. This is what we tell them.
- What is the Flat Rate VAT Scheme?
- How does Corporation Tax affect me?
- How does National Insurance work for a contractor running a limited company?
- What has to be entered on a Self Assessment Tax Return?
- What is income tax and PAYE?
- What is the tax on dividends
- As a Limited Company what are the tax requirements?
Q: What is the Flat Rate VAT Scheme?
The Flat Rate Scheme (FRS) was introduced to make filing a VAT return easier for businesses where turnover is less than £150,000. It works by allowing the business to simply pay HMRC a flat percentage of their gross turnover in VAT rather than calculate the difference between VAT charged and VAT reclaimed.
The percentage that has to be paid over to HMRC varies based upon the exact nature of the business activity and can range between 8 and 14.5%. Most Contractors providing consultancy services would fall in the 14 to 14.5% category.
The company would still charge clients 20% but pay less over to HMRC. For example:
- Invoice for £1,000 + VAT = £1,200 charged to the client
- Client pays you £1,200
- You pay HMRC (say) 14.5% of the gross value = £174
- You keep the difference of £26
This scheme often results in extra profits for contractors, although you need to be aware that it does not allow for reclaiming of VAT on purchases unless the item is a capital asset costing over £2,000.
The scheme may not therefore be suitable for contractors with considerable purchases, or contractors making zero-rated sales (on which the percentage would still be payable to HMRC, even though no VAT was charged).
The percentage payable in VAT is determined by matching the company activity against a list provided by HMRC. Potentially making registration even more attractive, there is a 1% discount in the first year of VAT registration.
Q: How does Corporation Tax affect me?
All limited companies that make a taxable profit are liable for Corporation Tax – this of course includes those set up for individual contractors to use.
For each accounting period profits are calculated for tax purposes and a Corporation Tax return (CT600) is submitted to HMRC.
If your company has taxable profits of up to £1.5 million, or less if you have associated companies, you must pay your Corporation Tax by the normal due date which is nine months and one day after the end of your Corporation Tax accounting period. For example, if your company’s accounting period ends on 31 May, your Corporation Tax payment is due on or before 1 March the following year. If you pay early HMRC will pay interest based upon the difference between the payment date and the due date.
A Corporation Tax accounting period can only last for a maximum 12 months, so you may find that you have two CT600 forms in any accounting period that is longer. This is very common in your first year, where your first accounts may cover 13 months.
The rate of tax paid does vary between large and small companies but most personal service companies will suffer the small company rate, which for the financial year to 31 March 2014 is 20%. The maximum taxable profit a company can earn in a 12 Month period before it pays more than the small company rate is £300,000. That limit is apportioned across associated companies, so be aware that companies under common control may suffer higher tax at a lower level of profit, and for shorter accounting periods.
The large company rate of Corporation Tax is 24% for the year ended 31 March 2013 and 23% for the year ended 31 March 2014, and applies to annual profits greater than £1,500,000. This is unlikely to apply to many contractors. What is very important, however, is to not fall into the range of taxable profits being greater than £300,000 because the “transitional rate” of corporation tax between the small and large company rate is the highest of all up to 25%.
In almost all cases companies should use bonuses, pensions or other mechanisms to ensure they do not fall into the punitive transitional band of Corporation Tax.
Q: How does National Insurance work for a contractor running a limited company?
Contractors running their own limited company pay two types of National Insurance (NI) through the business. Part of it is an employer liability and part of it is the employee’s (contractor’s) liability
Where an individual receives earnings and benefits from a limited company then the company has to pay Class 1 National Insurance on the earnings and Class1A on the benefits.
No contributions are payable on the first £148 per week (2013/14) but thereafter the employer pays at a rate of 13.8% without limit. The same rate applies to relevant benefits in kind under Class 1A.
An employee also has to pay National Insurance contributions on their earnings also under Class 1. The same exemption applies to the first £149 per week and then the rate is at 12% on the band until earnings reach £797 per week.
For amounts in excess of £797 per week the employee pays a reduced rate of 2% without an upper limit.
Q: What has to be entered on a Self Assessment Tax Return?
Directors may have other personal income from investments, savings or other businesses, which have to be entered on a Self Assessment Tax Return (SATR). For contractors and freelancers using limited companies to trade, the most common form of income tax due apart from PAYE on their salary/wages is on dividends they award themselves.
Each year SATR have to be filed with HMRC no later than 31 January (in the calendar year following the end of the tax year). Payment of any tax due is made in two instalments at the end of January and July starting in the tax year.
Q: What is income tax and PAYE?
Individuals pay Income tax based upon their earnings including benefits in tax years. Income tax normally comes from earnings as an employee and is paid to you after personal tax has been deducted. Tax deducted from your earnings is called PAYE (Pay as you earn).
Q: What is the tax on dividends
Dividends paid from a company are deemed to be paid net of 10% tax, so if you take £5,000 your tax return will show you received £5,555 and paid tax of £555 (even though you haven’t actually paid anything you retain the benefit of the credit).
As dividends are taxed at 10% up to the higher rate band, the tax that is due has already been paid, so nothing further is due. When you cross into higher rates the tax due increases to 32.5%, less the 10% tax credit, so 22.5% – this works out at 25% of the money you actually received. This additional tax, if any, is calculated and paid for on your tax return.
From 06 April 2010 there is a new additional rate of 42.5% on dividends paid when total income is in excess of £150,000.
Q: As a Limited Company what are the tax requirements?
From the company’s point of view it will probably have to submit VAT returns, and account for PAYE, National Insurance and Corporation Tax on profits. Individuals have to submit personal tax returns under self assessment.
If a company is VAT registered it must charge VAT on invoices it issues. The client then pays the total invoice value, and your limited company pays the VAT element over to HMRC each quarter. The amount payable can be reduced by any VAT your company has paid on business purchases, for example on stationery, telephone bills.
HMRC allow certain companies to register for VAT under the Flat Rate Scheme. This enables the company to simply pay a pre agreed (“flat”) percentage of turnover as VAT rather than calculate the actual amount due on sales less the amount repayable on purchases. The advantage of this is that it’s easier, and the company will make a small profit.
We will advise you on the VAT scheme appropriate to you, and the amounts that are due to be paid. It is then your responsibility to make the actual payment.
This is paid each quarter according to the tax and NI deducted from any wages paid. We will inform you of the amounts due in advance, and you simply then make the payment.
Corporation Tax is paid 9 months after your company year end, and is based on the profits.
Personal Tax this is payable each January and July, as per your self assessment tax return. The amount due depends on the value of dividends, rental income, bank interest, capital gains and anything else not taxed at source.
Q: Can I claim my Christmas Party Expenses?
Yes you can. HRMC provides a tax exemption, providing it is an annual reoccurring event. The maximum allowable spend per head is £150. If you would like partners of employees to be invited the allowable spend increases by a further £150 for each additional individual. More Information can be found in the Christmas Party Expenses Blog.
Q: What business expenses can you claim for?
Contracting through your own limited company allows each of the company’s employees to claim reasonable expenses.
A company can claim from a long list of expenses, but generally they must be “wholly, exclusively and necessarily for the purposes of the trade” in order to be allowable and you must have actually incurred the expense. Any expenses that have a personal benefit or can be seen to have dual purpose will often result in a benefit in kind charge, unless such use can be argued to be incidental.
The rules surrounding expenses are often subject to qualifying conditions so it is difficult to give a definitive list. The following general list should not be taken to be exhaustive and no responsibility is accepted for the eventual tax status of any claim.
- Employee wages — employees include any directors
- Contributions into employee private pension plans
- Up to £55 a week toward registered childcare — but be careful as this may affect any tax credit claims
- Business stationery and postage costs
- Subscriptions to professional bodies
- Technical books and journals required
- Business insurances
- Training costs incurred to upgrade current skills
- Use of home — a flat allowance of £4 a week can be claimed without receipts
- Accountancy fees
- Mileage, travel and subsistence
- Mobile phone bills if the contract is in the company name — if not, only identifiable business calls
- A broadband connection if private use is not significant and cannot be identified
- A computer, if your work requires one
- An eye test if you are required to use a computer screen
- Entertaining staff — up to £150 per head for an annual event such as a Christmas Party
- Company bank charges and interest
Q: What can you claim for when using your home as an office?
If you are purely using your home to carry out general administration tasks and do not have a specific room set aside for business use, the HMRC approved rate of £4 is the most suitable. You do not have to keep any records to back up your claims and any claim is unlikely to be challenged by HMRC.
Apportionment of costs
If you work from home on a fee earning basis and have a separate room set aside for the company, you could make a claim based upon the space used and the actual bills incurred. You must be able to show logical calculations and keep all invoices relating to the claim for the standard 7 years.
The following can be used to calculate the total cost:
- Council Tax
- Mortgage Interest
- Home insurance
- Internet line rental
- Telephone line rental and call costs
- Water rates
- Light and heating costs
The next step is to calculate the total floor space within your house, ignoring hallways, the bathroom and the kitchen and determine the proportion of the total space that is used by the business.
This amount should finally be adjusted for the actual hours in use. For example if you use the room for 8 hours out of a 24hour day the value should be reduced to 1/3 of the total (24 divided by 8).
We advise that you avoid claiming 100% business use of any space within your home, as it may have implications from a Capital Gains Tax point of view.
Q: What is considered a reasonable mileage claim?
HMRC issue guidance on what they consider to be the maximum “reasonable” rate of reimbursement and as a consequence any rate used to reimburse employees, that is lower than or equal to, HMRC’s statutory or recommended rate is not taxable as a benefit to the employee.
If the company provides the car but the employee pays for all fuel then fuel claims for business mileage can only be for the fuel itself and therefore will not include an element for other costs. Where the employee uses his own vehicle the allowable charge can include elements for wear and tear, tyres, and other running costs.
HMRC offer advisory guidance for fuel only rates of between 15p and 26p for petrol and 12p to 18p for diesel. For employees own cars 45p for the first 10,000 miles and 25p per mile thereafter are the statutory maximum rates.
Q: What mileage can I claim?
Contracting through your own limited company gives you the opportunity to reduce your tax burden by allowing you to claim travel costs for your work related travel, subject to the rules below.
Employees are entitled to be reimbursed by their employers for business mileage costs that the employees have incurred personally. These reimbursed costs are deductible as expenses in the company. Provided the claim is not unreasonably high reimbursement is not taxable in the hands of the employee.
Q: What is a ‘benefit in kind’?
As a contractor who is a director and/or employee of their own company it is especially important for you to keep a clear line between personal and business expenses, many of which can be paid for by the limited company, but as a consequence of the company paying private expenses they will be treated as benefits in kind.
The term “benefit in kind” refers to the value of any extra benefits an employee enjoys by virtue of their employment. Common examples would include medical insurance, a company car, clothing (unless specialist protective clothing), computer equipment used privately and no/low interest loans.
The benefits and amounts are reported on a form P11D each year, with extra employer’s national insurance also being due. There is likely to be extra tax due from the employee that is disclosed on their Self Assessment Tax Return. Generally the taxable value is based upon the cost of providing the benefit, but for some benefits tables or formula are used to identify the “cost” of provision.
Q: How is private mileage calculated?
When fuel is made available for any private mileage an additional tax charge arises on this second benefit. The taxable benefit is calculated taking the percentage figure from the emissions calculation, and multiplying by £18,800 in 2011-12, increasing to £20,200 in 2012-13.
There are more detailed rules regarding company cars, which can be explained on request.
Q: How do you estimate the value of the Company Car benefit?
The value of the car benefit to an employee is based upon the CO2 emissions of the vehicle and the list price. Most cars fall within a range of 15%-35% of the list price being the assessable benefit cost per annum with higher emissions attracting a higher percentage.
Q: Is a company car tax efficient?
As a contractor using your own limited company to contract through, it may be more tax efficient for your business to purchase and maintain a vehicle or for you to own and run it personally. The best answer depends on questions such as; how many business miles you will drive in a year? And which car you have? Mini or Mercedes!
When a business purchases a vehicle it is as a benefit to a director and it is usual for the business to meet all running costs of insurance, road tax, repairs and servicing. The company may pay for fuel costs but this also has benefit in kind implications for the employee receiving the benefit, if any private mileage is paid for or is subsidised by the company.
Q: What are reasonable travel and subsistence expenses?
- Mileage to and from the client site can be claimed if you use your private car or motorcycle. You can of course also claim for taxi, bus, train and airfares. Parking and congestion charges can be claimed, but speeding or parking fines cannot.
- You can also claim the cost of your lunch, but ensure the cost is reasonable and that you keep receipts. Never claim round sum amounts as estimates, they could simply be disallowed in full by HMRC. You cannot claim the cost of buying ingredients at a supermarket and using them to take a packed lunch each day.
- If you take clients to lunch the cost will be deemed as entertaining, and while the company can pick up the bill it is not tax deductible. The only entertaining that will be allowable is staff entertainment under specific rules.
- If you’re staying away from home you can claim the cost of any accommodation, lunch and an evening meal. There is no set limit for an evening meal, but it must be reasonable. InTouch suggests £25 as a guideline. You can also claim £5 a night for incidental expenses that you don’t need to keep receipts for.
- If you start work early you can claim the cost of breakfast, unless it’s a regular occurrence.
- If you’re away for business reasons “longer term” you can claim the cost of renting accommodation, just bear in mind that you may have to prove it’s a cheaper alternative than a hotel of a reasonable standard.
- You will not be able to claim rent if the accommodation is your only accommodation (you need to have a separate home elsewhere).
Top 10 questions
These are our 10 most frequently asked questions
- Can I claim my Christmas Party Expenses?
- What business expenses can you claim for?
- What can you claim for when using your home as an office?
- What is considered a reasonable mileage claim?
- What mileage can I claim?
- What is a ‘benefit in kind’?
- How is private mileage calculated?
- How do you estimate the value of the Company Car benefit?
- Is a company car tax efficient?
- What are reasonable travel and subsistence expenses?