Best Financial Options for Contractors
We look at the best financial options available for UK Contractors.
Retention levels available for contractors
One of the key decisions for contractors is which method to contract through.
This impacts on the amount of your fee you actually keep after taxes, administration and accountancy.
They have put this further into the spotlight following the changes to dividend taxation and travel and subsistence expenses for employees.
However, these changes will have a negative impact on the amount of money that will end up in your bank account.
So, contractors will pay extra amounts in tax and national insurance once the changes come into force.
Below is a summary of the options available and a summary of their position for tax and the likely level of retention a contractor can expect.
For the purposes of the article we will assume that the contractor is a single IT worker, of 40 with a standard tax code and a 12 month contract for £350 per day.
He works 5 days per week and 48 weeks of the year (annual income of £84,000).
This worker spends £8k per year on travel and subsistence.
Self Employed Contractors
There has been no significant impact to the status of a self-employed person. As before, the key obstacle is IR35 (and the rules are going to be subject to revision).
So, a self-employed person has to pay Income Tax and class 2 and 4 National Insurance.
Other than the deduction of expenses that relate directly to their employment, there are no commonly used methods of tax planning.
In addition, the self-employed person has to either undertake all administration for invoicing and collection.
Plus they also have the responsibility for making payments for tax when they fall due, or engage an accountant to do this.
There may be a large tax bill at the end of the period to settle.
So, the contractor here would retain 67-78% of their income.
Limited Company Contractors
The ability to use dividends is a key element in tax planning for those contractors who operate Limited Companies.
Dividends are taxed at a much lower rate than salary. There is currently an effective rate after tax credit of
- 0% up to £31,785,
- 25% above this up to £150,000, and
- 30.56% on any earnings above £150,000.
Going forward the removal of the tax credit on dividends will result in dividends being taxed at 10% up to £31,785.
Although there is a £5,000 tax-free dividend allowance.
They will tax them at 32.5% above this up to £150,000. They will aslo tax them at 37.5% on any earnings above £150,000.
So, this change will have a huge impact on contractors that operate a Limited Company. The benefit of making drawings in the form of dividends rather than salary has been greatly reduced.
In the 2014-15 tax year, our Limited Company contractor could retain 72.92% of their income.
However, moving forward into the 2015-16 tax year this will drop to 65.79% due to the changes in dividend tax.
There will, also, be costs associated and administration associated with the operation of a Limited Company.
There will, also, potentially be the need to control invoicing and collect payments.
Umbrella Company Contractors
Becoming an employee of an Umbrella has been a popular method of tax planning and also reducing the administrative burden for contractors.
The Umbrella will manage all invoicing, collection and taxation matters and pay the contractor their net fee.
By becoming an employee of the umbrella, it enables the company to deduct travel of subsistence expenses. These are not allowable deductions of self-employed workers.
Therefore, in the case of our contractor, using an Umbrella under current rules would provide a retention of 63.96% of their fee.
So, going forward into the new rules for Umbrellas, the retention drops to 59.30%.
Limited Partnerships Compliance with UK Tax Rules
Among the rules they have ensured their compliance with are:
1. Transfer of Assets Abroad Legislation – Chapter 2, Part 13 ITA 2007
3. GAAR – Section Part 5 FA 2013
5. Part 3, Chapter 7, ITEPA 2003
6. The newly announced Onshore Intermediaries guidance, 9 July 2015
Best Financial Options for Contractors Summary
So for each of the four options, the expected retention after taxes and fees is as follows:
Route 2014-15 2015-16
Self Employed 67.78% 67.78%
Limited Company 72.92% 65.79%
Umbrella 63.96% 59.3%
Tax Efficient Limited Company – No less than 85% No less than 85%
So, choose the best financial options for you.