How to Save Tax as a Contractor
From Corporation Tax to National Insurance, every UK business is required to pay a range of different taxes. As a contractor operating your own limited company it is a significant responsibility to stay on top of your tax payments (with support from your accountant) but, on the plus side, when you’re working for yourself there are numerous ways that you can reduce your tax bill and stay on the right side of HMRC:
Maximise legitimate expenses
From mileage claims to equipment purchases contractors run up a significant list of annual expenses, and all of these expenses can be offset against company profits, thus reducing your corporation tax bill. You must ensure you're recording and claiming only legitimate business expenses, and keep a record in the form of receipts and expense logs, but the list of things you can claim is satisfyingly long – you can see an overview here.
Pay yourself a small salary and top up with dividends
Your salary is subject to income tax and National Insurance payments, so it’s useful to keep it small and then use dividends to withdraw more profit out of your business. You will still be paying corporation tax (around 20%) on dividends, but the corporation tax rate is significantly lower than the tax rates that apply to your salary. It’s a very simple process to generate dividends and an excellent way to minimise tax payments – you can find out more about them here.
Maximise company pension contributions
Pensions represent one of the most efficient tax breaks available to contractors. By investing money directly from your limited company into a pension scheme you can avoid both income tax and national insurance contributions that would ordinarily be payable on that cash. While there’s a degree of hassle and uncertainty involved with hunting out your own pension, it also means that you have the luxury of choice – so it’s well worth consulting an independent financial advisor to help you find a pension that is secure and tax efficient. You can find an overview of some of the most common contractor pension options here.
Steer clear of IR35
Understanding and working outside IR35 is critical to keep your tax bill as low as possible. The introduction of IR35 has led to the reduction of tax breaks for contractors caught within the legislation due to the terms of their contract: by understanding IR35 and seeking contracts that keep you outside of the legislation you will inevitably reduce your tax burden.
Keep cash in your business
Keeping as much cash as possible within your limited company will help you to stay in a low tax bracket – it also offers you peace of mind in the event that you encounter a slow period of business or wish to take an extended break. This is another excellent reason to set up a limited company – it gives you a far greater degree of control when it comes to managing your profits.
Review your VAT method
It's important to occasionally review the VAT method used by your company; this will both help you to stay on top of VAT rate changes and keep your tax bill as low as possible. For example, you may benefit from applying the flat rate VAT system as opposed to the standard or cash accounting scheme, or vice versa. You can get details on how flat rate compares with standard VAT here.
Get a Second Opinion
Tax is a complicated subject, and before you embark on your tax-saving strategy it’s worth chatting to your accountant to ensure everything is in order. If you’ve found yourself a specialist contractor accountant they will be extremely well versed in reducing contractor tax burdens and should be able to ensure that you’re employing every trick in the book to keep your tax bill low.