Contractors: find your way through the tax maze
Taxes that you need to pay as a contractor
Working as a contractor has a great number of benefits, but the one downside (maybe) is taking responsibility for what taxes have to be paid.
Most contractors choose to operate via a Limited Company as it is the most tax efficient route. However, as a director of the Limited Company, you will be responsible for making sure the correct taxes and the right amount of taxes are paid on time.
Engaging the services of a specialist contractor accountant will lessen the burden of working out what taxes are due and when. However, ultimate responsibility still lies with you.
Making your way through the muddy maze of tax
We are not suggesting you become an expert in taxation (that is what we are here for) but it is important to have some knowledge of the taxes you will be required to pay.
To understand what tax is due and when, it is simpler to break it down into the tax your Limited Company has to pay and the tax you have to pay, also known as Personal Tax.
Corporation Tax is a tax on company profits. Current rate is set at 20% and will fall to 19% for the year beginning April 2017, and to 17% for the year beginning 1 April 2020.
If you have taxable profits of up to £1.5 million, Corporation Tax must be paid 9 months and 1 day after the end of your accounting period.
If taxable profits are more than £1.5 million corporation tax must be paid in instalments.
VAT is an extremely complicated area of tax. A lot of first-time contractors are unsure if they are required to be VAT registered. Our article ‘To VAT or no to VAT that is the question’ looks at who is required to be VAT registered.
For contractors who are required or want to be VAT registered, choosing the Flat Rate Scheme (FRS) is the easiest option. Our article ‘Choosing the right VAT route’ explains the Flat Rate Scheme in further detail.
What happens if I get VAT wrong?
If you make a late VAT payment to HMRC, it could be recorded as a ‘default’. Following this, you enter into a ‘surcharge period’ which usually lasts 12 months. If during this period you ‘default’ again, you may have to pay an extra amount on top of the VAT you owe. Further information on VAT surcharges and penalties can be found on the .Gov website.
Supplying incorrect information that could lead you to “underestimate the tax due” or “mispresent the tax liability” could see you being hit with a penalty charge. Each tax has its own specific rules when it comes to charging penalties. In general, the size of the penalty charge depends on how the mistake was made, for instance, if:
- the mistake was made through a lack of reasonable care (e.g. not keeping accurate records) the penalty will be between 0%-30% of the extra tax due
- the mistake was deliberate, the penalty will be between 20%-70% of the extra tax due
- if the mistake was deliberate and it was concealed, the penalty will be between 30%-100% of the extra tax due
As a director of your Limited Company, you need to register for self — assessment and complete a personal tax return, the tax year is 6 April 5–5 April the following year.
You need to register if you haven’t previously filed a tax return. The deadline for registering is 5th October following the end of the tax year in which your income first arose.
Once registered, you can either submit your return by completing a paper tax return or by filing online.
Filing Dates — avoid unnecessary penalties by missing the deadline:
- A paper tax return must be received by HMRC by 31st October following the end of the tax year.
- Online tax return must be received by HRMC by 31st January following the end of the tax year.
- The deadline for paying the tax you owe is 31 January.
You will get a £100 penalty if your tax return is up to 3 months late.
If you take a salary from the Limited Company (most contractors take a small salary and the remainder via Dividends), this is taxed via Income Tax. The amount of tax payable depends on the amount of income that is over the Personal Allowance and how much of this falls within each tax band. For 2016/17 the Income Tax rates and bands are:
Income up to £11,000 = 0% (assuming you have the standard personal allowance of £11,000)
Basic rate: £11,001 — £43,000 =20%
Higher rate: £43,001 — £150,000 =40%
Additional rate: over £150,000 =45%
Note: Your Personal allowances may be more if you claim marriage allowance or less if your income is over £100,000.
Please note that under the new dividend tax regime you will be liable for additional dividend tax on any dividend income over £5,000 that is not covered by your personal dividend allowance.
The tax bands will be 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
If you are subject to any additional tax liability, it is paid through the personal self-assessment tax return system.
Tips to reduce the risk of getting it wrong
Our simple advice is, when it comes to tax, check everything carefully and seek expert advice. We have included some tips to help you from making mistakes:
- Be honest, never try to hide anything
- Read all paperwork thoroughly and seek help if you are unsure of anything
- Fill in all relevant sections
- Return paperwork within the time stated
- Pay your taxes on time
- Keep organised records (rushing around to find invoices / receipts etc, will lead to you making mistakes)
- Review your accounts regularly
- Employ the services of a specialist proactive accountant (such as ourselves) who will advise you on the amounts to pay, when to pay and who to pay it too.
If you think you have supplied your accountant or HMRC will incorrect information, contact them immediately. It is better to admit your mistake and deal with the consequences.We will be covering PAYE and the penalties for late payment in another separate article.
We will be following this article up with a in-depth article discussing PAYE and the penalties for late payments.