If you are a self-employed freelancer or established as a limited company, business profits are subject to different types of tax.
Of course, this makes managing tax increasingly complicated. Due to the complexity of the tax structure, it is generally advised that limited companies source a personal accountant to help maintain accurate business records, deal with statutory obligations and make company profits more tax efficient. Furthermore, consulting with a specialist accountant can ensure that you pay the minimal necessary tax.
This article attempts to highlight the tax structure that company profits are subject to and provides a brief overview of the differences between each one. Put very simply, your personal finances and those related to the company, are treated as isolated entities. Therefore, before payments can be allocated to employees or shareholders, company profits need to be taxed appropriately.
Below are brief descriptions of the different types of tax which company profits are subject to:
Corporation tax
All limited companies are required to pay Corporation tax on annual profits. Once the company has been incorporated, your company must be registered for VAT by your accountant. The specialist accountant can also prepare business accounts for annual reporting and submit these to Companies House and HMRC.
Value Added Tax (VAT)
The majority of contracting companies have to be registered for VAT. This demands that invoices from limited companies include VAT charges. These charges are collected on behalf of HMRC by the limited company. The charges collected must be acknowledged during quarterly updates. The VAT charges do not influence company profits, although some small businesses choose to register for the flat rate VAT scheme to reduce VAT payments.
National Insurance
It is worth noting that NICs are only payable on salaries, not dividends. The NICs for each company is dependent on the amount of your gross salary. Many contractors elect for a low salary, to minimise expenditure on income tax and NICs. For this reason, it is often worth consulting with a professional accountant to establish the appropriate annual salary that you should take.
Income Tax
For self-employed freelancers or businesses viewed as one entity by HMRC, directors must calculate income tax via a self-assessment process to establish income tax liabilities at the end of each tax year. Establishing a limited company is revered as being more efficient from an income tax perspective, as you can allocate a small salary (with reduced tax liability) and then individuals can also pay themselves in dividends.
Company directors are required to complete self-assessment tax return and the system assumes that you earn the same income annually. Due to the complexity of personal taxes being treated separately to company related tax, it is often worth liaising with a professional accountant to ensure that dividends and any other income during the financial year are subject to the required taxation.
Another important consideration regarding contractor tax for limited companies is intermediaries legislation (IR35). If the contract is caught by IR35, then all income is paid via a deemed salary (subject to PAYE). Evidently, it is advantageous that your contract is not caught by IR35 to minimise tax return.
This additional complexity further advocates the use of a personal accountant to effectively manage the amount of contractor tax needed. Almost all limited companies hire accountants to assist them generating accurate business records and support their accounting needs. Due to superior knowledge regarding tax bands, specialist accountants may minimise tax rates. Of course, this will be unique to each business and so it is not uncommon for accountants to offer a personal service bespoke to each company, through a range of packages.
You can get in touch with one of our dedicated accountants by calling 0330 024 0406, or email info@gorillaaccounting.com.
