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.
Take Home Pay FAQ's
Take Home Pay
- How does the National Minimum Wage affect a contractor?
- What is the tax on dividends
- What is the dividend tax rate?
- What are dividends?
- How do dividends and Corporation Tax work?
- What about tax and a Personal Pension?
- What tax do I pay on my dividends?
- What do I need to know about taking dividends?
- How do I take a tax efficient salary from my Limited Company?
- What are the limits on dividends?
- What do I need to know about limited companies and pay?
- How do I reduce my tax burden?
- How do I create timing advantages in the payment of tax
- How do I use dividends rather than my salary
- How do I only make taxable the income I need?
- How to profit from VAT?
- How do I claim more expenses?
Q: How does the National Minimum Wage affect a contractor?
It is generally accepted that paying a Company director or senior employee at levels below the National Minimum Wage (NMW) could be seen as un-commercial. Where that director is also a majority shareholder IR35 risks may be increased.
From 1 October 2013 the minimum wage rate for people aged 21+ was increased to £6.31 per hour, which for 35 hours a week and 52 weeks a year, comes to a little over £11,400 per annum.
Another indicator of when the NMW may apply to contractor and freelance situations depends upon whether or not the main director has a contract of employment with his limited company. If he does then the NMW should apply. If he does not have a contract then NMW does not have to apply but you should still be wary of a lower level seeming un-commercial in the eyes of HMRC.
Contractor wages taken under PAYE cannot be subject to increased taxation under IR35. For sensitive questions like this we want you to talk to us directly so contact us for an answer to your particular circumstances.
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 2013 there is a new additional rate of 37.5% on dividends paid when total income is in excess of £150,000.
Q: What is the dividend tax rate?
Dividends paid from a company are deemed as paid net of 10% tax, so if you declare a dividend of £5,000 your tax return will show you received £5,555 and paid tax of £555 (even though you haven’t actually paid any tax you are treated as if you had). It is the gross value, being £5,555, that you are deemed to have received for tax band purposes.
Below the tax threshold rate
As dividends are taxed at only 10% up to the higher rate threshold, (which starts at £31,865 for 2014/15) the amount of tax that you are “notionally” deemed to have suffered at source is sufficient to cover this liability. Nothing further is due provided you have no other income in the tax year.
Above the tax threshold rate
When your total taxable income is greater than £31,865 (2014/15) plus your tax code, usually 1000L to give a basic rate band of £41,865, higher rates may be payable. Once into higher rates the tax due on dividends increases to 32.5%. The benefit of the notional 10% deemed to have been suffered remains, so 22.5% is the actual rate of tax charged on the gross dividend. Based on the net cash you actually receive the rate of tax is actually 25%. This additional tax, if any, is calculated and paid for via your tax return. If gross income is greater than £150,000 the rate of tax increases to 37.5% (less the 10% credit) = 27.5%, but only on amounts in excess of this limit. There are obvious attractions to using dividends in concert with salary and pension payments, but please speak to us personally to identify the risks and the advantages.
Q: What are dividends?
Contractors owning their own limited company have the advantage of being able to pay surplus profits to themselves via dividends as well as through a salary, which gives many advantages.
Dividends are not an expense of a business. Dividends paid to shareholders are an “appropriation” of profit (in other words how the profit is used). The main difference is that wages get tax relief in the Company and are deducted in calculating what the company’s profits are. The payments of dividends do not count as a business expense and are not deducted when calculating a company’s profits.
Unlike wages, dividends can only be paid from available net profits – that is cash or other assets remaining in the company after a provision for Corporation Tax. Care is required because the maximum dividend payable is not necessarily the same as the balance in the company bank account!
However, wages and dividends are also taxed differently.
Q: How do dividends and Corporation Tax work?
A dividend should only be paid from company profits. In order to calculate the profit you must take into account net sales, less expenses, and less an allowance for the expected Corporation Tax that will be due for the year. Anything that remains, plus or minus any retained profits or losses brought forward, is then available for dividend distribution.
When calculating your optimal pay structure you should keep in mind that dividends do not reduce the Corporation tax you pay, whereas salary and pension contributions do.
This general advice must be taken in context with your overall tax and commercial circumstances before you decide what is best.
Q: What about tax and a Personal Pension?
A limited company can pay up to £40,000 per year into an employee’s personal pension, and will get Corporation Tax relief for those contributions. You should ensure that the payments go direct from the company bank account to the pension provider.
Pension contributions are also an allowable deduction for IR35 deemed salary calculations.
Before making any payments you should discuss with your Independent Financial Advisor to ensure you are fully aware of all the facts.
Q: What tax do I pay on my dividends?
If you have a normal tax code and you pay a salary of £10,000, you can take up to £28,678 in net dividends before paying any personal tax (assuming no other income such as bank interest, rental income or other salaries). If you withdraw anything above that £28,678 (up to the additional limit) you can expect a tax bill of 25% of the amount you take — so if you take £40,000 in dividends, the tax will be £2,831 (25% of the extra above £28,678).
Dividends above the additional rate limit will be taxed at 30.6% of the amount you take (or 37.5% of the gross).
Q: What do I need to know about taking dividends?
It is efficient to take any further income in the form of a dividend. In the hands of an individual dividends are effectively tax free up to the higher rate income tax limit, and taxed at 25% of what you take above that. The tax rate increases at the additional rate limit, but only if your total income exceeds £150,000.
A dividend is simply a transfer from the company bank account into your personal account, with the appropriate dividend voucher completed (we supply a template for you to use). Any dividend transfers should be kept totally separate from payments made for wages or expenses so that HMRC can clearly identify them if necessary.
Q: How do I take a tax efficient salary from my Limited Company?
The salary level you chose to take is up to you but we recommend you set it at not less than £7,956, which is the lowest level you can pay and still get credit for NI purposes (which is important for certain state benefits). If you would like to be less aggressive you could set a level equal to National Minimum Wage — around £11,000 to £12,000 a year. This is deemed by some to be a more commercially realistic level, and remunerating yourself below this level has been shown to be disadvantageous if debating IR35 issues with HMRC.
In the current fiscal year, up to 5 April 2015, assuming your company qualifies to claim the Employer Allowance, the most tax efficient salary to take is that equivalent to your tax code (generally £10,000 per annum or 1000L).
Q: What are the limits on dividends?
There are two factors you should consider when thinking about the limits on dividends – the company and you personally.
A company can only pay dividends from profits, so you should review your accounts to determine what the available profit is. This is not as simple as the balance in the bank account as accruals have to be made for various taxes. If you are not sure then simply ask us, and provided your portal is up to date we can prepare management accounts for you.
From a personal point of view you should then consider the impact that a dividend will have on your own individual tax liability. What other income do you have in the current tax year and what, if any, further liability will result from this dividend? Are you taking out enough to cover the money you need plus the tax that will be due? Again, if you are unsure then please feel free to ask your Client Manager who will be able to review your tax position and advise on the implications.
Q: What do I need to know about limited companies and pay?
One of the most important principles to grasp early on is that the money in the company bank account does not belong to the directors, it can only be withdrawn in the form of wages, dividends, expenses or a loan.
A wages summary will be prepared and sent to you that sets out the amount to pay yourself each month, along with the payments that need to be made by the company to cover PAYE and NIC (if applicable). Expenses are simply the amount of money you have spent on behalf of the company and now need to reclaim. We recommend this is done on a monthly basis.
Q: How do I reduce my tax burden?
When you want to extract money from the business you have the choice of either paying a dividend to yourself as a shareholder (owner) of the business or paying yourself a salary or bonus as a director (employee). These two methods can be structured in a way that legitimately reduces the overall tax burden. Additionally a limited company pays corporation tax on its profits, after salaries have been deducted but before dividends. All of these different taxes are at different rates and work under different rules.
Q: How do I create timing advantages in the payment of tax
Rates of taxation and tax thresholds before the rates increase are set and may change every year in the budget. Using the flexibilities that come with your own limited company (and using the advice of an accountant) enables contractors to use these thresholds to their advantage and can also delay the payment dates of tax from one year to the next year.
Q: How do I use dividends rather than my salary
Dividends do not attract employers or employees national insurance tax (unlike wages).
Dividends are taxed differently under income tax. Dividends forming part of your overall personal income in a tax year receive a “tax credit” in the company when paid. Without any tax actually being paid the basic rate is assumed to have been paid by the company. So for the tax year 2014/2015 if total income including dividends is less than £41,865 no tax is payable on the dividend received (assuming the standard tax code). For income levels between £41,865 and £150,000 the effective rate of tax on the dividends is not more than 25% – Better than income tax rates of 40%!
Q: How do I only make taxable the income I need?
As an umbrella or sole trader all of your income (after allowed expenses) is taxed as it is earned at the highest rate of income tax that applies. This is up to 40% for income levels up to £150,000, and even 45% beyond that (2014/2015). It is also difficult to manage the timing of this tax burden. BUT as an employee (director) of a limited company, you can choose the level of income you take as salary in any tax year and match it to your needs. Any undrawn or “surplus” amounts can be left in the business for the future and will be taxed once only at normally 20%. In the future when you need the cash, retire or exit contracting your can call upon these funds.
Q: How to profit from VAT?
By voluntarily registering your business for VAT and transferring to the Flat Rate scheme most contractors are able to make a “profit” from following the rules. It works because your business charges VAT to the end hirer at 20%, but only has to pass on a lower amount to HMRC (commonly 13-14%). The taxman assumes the difference is the amount of VAT you will suffer on costs and is happy. In reality the amount of VAT suffered by most contractors is much lower than this generous allowance and they benefit from the difference. The VAT surplus is treated as income and taxed in the company but nevertheless it remains generous.
Q: How do I claim more expenses?
No other method for trading as a contractor allows you to claim more expenses incurred by you and your business than those available when trading as a limited company. With very few exceptions expenses necessarily incurred for the purposes of your trade get tax relief in the company at the most common company rate paid by contractors of 20%.
Q: When do I need to register for VAT?
VAT registration is mandatory for companies who have made taxable sales in the last 12 months above the current VAT registration threshold amount. For the 2013/14 tax year this is £79,000. HMRC usually increases the threshold by around £1,000 each year so for the 2014/15 tax year the threshold is likely to be higher. Even if your sales are unlikely to reach this level you can still voluntarily register your company for VAT. Many contractors choose to do this as it can offer several advantages as claiming back VAT on invoices they receive. If you decide not to register but you believe you’ll exceed the threshold in the near future (if you win a huge contract for example) you should register as soon as possible to remain within HMRC rules.
How to register for VAT
You need to apply directly to HMRC to register your company for VAT. This can be done online using their website or by post. You can do this yourself or your InTouch accountant can do this for you on your behalf.
Quarterly VAT returns at InTouch
At InTouch Acounting we offer Quarterly VAT return administration as a standard part of our comprehensive Monthly Service package (£92 + VAT per month). Contact us to find out more about our services and how we can help take the stress out of running your business.
Q: How is an IR35 case decided?
It’s easiest to use an analogy to show this works, for example a builder. If you ask a builder to come and build a fence for you agree with him what the end result will be but it’s entirely up to him how he does it, you don’t tell him how to build the fence. He is subject to certain constraints such as where you want it built, and he might need to work certain hours as you wouldn’t want him to turn up at 2am, but you don’t control how he does what he does. It’s also entirely possible that on day 2 his building partner turns up and takes over, which you don’t care about as long as the work gets done and the replacement person is equally as good. You also don’t care if he brings in someone to help him, as long as he’s not charging you extra. Once the fence is built the builder has no expectation that you’re going to find him something else to do, he can turn down further work if you do offer it, and you have no responsibility to find him anything to do ever again. If he does a bad job you can ask him to correct it free of charge or take legal action, and he will no doubt have insurance in place for just that reason. You may delay paying him, or refuse to pay until he provides an invoice.
An employee turns up at work each day and you can tell them what to do, how to do it, when to do it and where to do it. They cannot send a replacement person. They expect that when they finish one task you’ll find them something else to do, and in turn you expect them to carry on working on a new task when they finish the old one. They have performance reviews, sick pay, holiday pay and potentially pension or bonus schemes. They go to staff events, staff training, park in the staff car park and their name is on the internal contact list. They are very much ‘part and parcel’ of the company. If they make a mistake, they correct it in the employer’s time, and there’s rarely any suggestion that they could be sued (unless they are guilty of fraud).
This is obviously quite simplistic, but it’s how IR35 cases are decided. HMRC (or the Courts) will look at where you fit in between those two extreme examples, and if you’re deemed to be an employee then you’ll have tax and NI to pay on what you should have taken as wages (which is 95% of your income).
Q: How will I know if my contract is within IR35?
IR35 itself depends on several factors, and this isn’t just the written contract itself but the theoretical contract that exists between you and the end client. It’s therefore not possible to avoid IR35 purely by having a well written contract, as it would simply be dismissed as a sham if it’s not realistic.
1. Personal Service - if the contract requires you specifically then it is a contract of service and therefore a pointer toward employment. If you can send a substitute then it is a contract for services which cannot then be seen as employment. This is often deemed the strongest argument against IR35, providing it is a genuine right and not merely an ability to offer a substitute.
2. Control - this covers how, when and where the work is carried out. If you have reasonable autonomy over the work to be done then you would be more likely to be seen as a contractor. If you are told what to do and how to do it, and are expected to work set times for a set fee, it is more indicative of employment.
3. Lack of Mutuality of Obligation (MOO) - this relates to whether you are obliged to carry out the work and whether the client is obliged to offer you work, and also whether you are obliged to carry out work outside the scope of the contract. This applies not only after the current contract finishes, but within the current contract itself. MOO is the most difficult one of the three factors to prove, although the MBF Design case in January 2011 was won by the taxpayer with heavy emphasis on this point.
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 14p and 24p for petrol and 12p to 17p for diesel (effective from 1 June 2014). 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 £21,100 in 2013-14 increasing to £21,700 in 2014-15.
There are more detailed rules regarding company cars, which can be explained on request.
Top 10 questions
These are our 10 most frequently asked questions
- When do I need to register for VAT?
- How is an IR35 case decided?
- How will I know if my contract is within IR35?
- 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?
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