Contractors generally keep on top of their limited company’s affairs through regular chats and email exchanges with their accountants. And, according to Derek Kelly of contractor accountant ClearSky, most limited company contractors have similar questions about the same sorts of issues.
“Although every contractor’s business is unique, those trading through limited companies are all operating within the same regulatory framework laid down by company and tax laws,” explains Kelly. “That means many of the questions we are asked are similar, as are our responses.”
So, based on the calls taken daily by ClearSky’s qualified accountants, Kelly shares with ContractorCalculator common answers to typical contractor questions.
1. What insurances do I need?
If there are no employees and a sole contractor director, then Kelly says that a contractor limited company does not legally require any insurance in order to trade. However, he warns that trading without insurance may be risky at best and might be impossible because of client or agency demands. “Public liability and employer’s liability insurances are inexpensive and worth having, while most agencies and clients require contractors to hold professional indemnity insurance.” Insurances can also help contractors prove they are outside IR35, as taking out policies indicates financial risk and highlights a contractor’s ‘in-business’ status.
2. When can I take dividends?
“Technically, as long as a contractor’s limited company has distributable reserves, a contractor could take dividends daily, weekly, monthly, quarterly or annually – whatever suits their needs,” says Kelly. “In practice, most contractors opt for monthly dividends. But the company must have reserves otherwise the dividend is illegal, becomes void and the payment must be classed as salary or a director’s loan.”
3. Does the amount of salary I take have any bearing on the risk of me being investigated by HMRC?
In Kelly’s experience, the level of salary taken by a contractor has no bearing on the risk of being investigated by HMRC, nor is he aware of any current campaigns by HMRC targeting directors on low or zero salaries. However, Kelly recommends that contractors do pay salary at the level of National Minimum Wage (NMW) to ensure they pay a small amount of National Insurance Contributions (NICs). This enables contractors to access benefits such as Job Seekers Allowance and the state pension, which are triggered by National Insurance payments.
4. Can I change my company share structure and to whom can I give my shares?
“Contractors are free to change share classes and give shares away, but changing the capital structure of a business can be complex and expert advice should be sought,” explains Kelly. “Any changes after the initial ‘subscription’, when the company is first incorporated, will have tax consequences. For example, changing share ownership between husband and wife usually has no capital gains tax implications, but giving shares to a sibling, or even a life partner, will.”
5. What happens when I am no longer contracting?
Kelly warns contractors that running a limited company is not like joining and leaving an umbrella solutions provider; a company can’t simply be turned off and on again. If a contractor is planning to stop contracting for more than a couple of years, they might want to close the company and should work with their accountant to go through this process correctly. “Even if their company is not trading, contractors must still complete VAT returns, company accounts, corporation tax returns and payroll forms,” he adds.
Although every contractor's business is unique, those trading through limited companies are all operating within the same regulatory framework laid down by company and tax laws
Derek Kelly, ClearSky
6. How do I pay National Insurance Contributions?
According to Kelly, contractors trading through a limited company only have to pay Class 1 National Insurance Contributions (NICs) on salaries, and then only when paying a salary above the NIC threshold or when a Benefit in Kind (BIK) is paid: “Employee’s Class 1 NICs are only paid on salaries greater than £139 per week, and employer’s NICs kick in slightly lower at £136.” They are paid via a contractor’s company payroll, which is usually set up by their accountant, or can be set up by a payroll agency or the contractor him or herself. Class 2 and 4 NICs are only paid by sole traders and no NICs are paid on dividends.
7. Can my company invest?
“Contractors frequently make investments using their limited companies and the most common investment is purchasing buy-to-let properties,” continues Kelly. “There are virtually no restrictions on using company cash to invest, as the limited company is a separate legal entity. The company pays corporation tax on the profits of any investments but then the challenge is for the contractor is to extract the cash tax efficiently. Sometimes it can be more tax efficient to make investments personally.” As this can be a complex area, Kelly urges contractors to seek professional advice before making any serious decisions.
8. Is my contract IR35 friendly?
A contract might be IR35 friendly but if it bears no resemblance to the real working arrangements between a contractor and their client then it will be disregarded. “HMRC and the courts are more interested in the working practices and if these do not reflect what is written in the contract, then the contract will be written off as a sham,” says Kelly. “A contract should genuinely reflect how the contractor provides their services.” This is another area where Kelly recommends seeking expert advice if the contractor is unsure of their IR35 status. A good starting point is using ContractorCalculator’s free online IR35 status test.
9. Do I pay taxes on dividends, and what other taxes do I have to pay?
At the time of writing, contractors pay income tax on dividends according to the following schedule:
- Basic rate: no further income tax
- Further/higher rate (the 40% rate): 25%
- Additional/top (the 50% rate): 36.1%.
Contractors do not pay National Insurance Contributions (NICs) on dividends, but do pay income tax and NICs on salaries. “Contractors with more complex incomes and investments may also pay capital gains tax,” adds Kelly, “and any gifts may be subject to inheritance tax (IHT). In addition, their limited company will pay corporation tax.”
More detailed answers to these and other questions typically asked by contractors can be found on ContractorCalculator and in the Contractors’ Handbook. For more specific queries on the running of their contractor limited companies, contractors should seek advice from specialist accountants and other professionals.
Published: Monday, May 16, 2011
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