If you decide to contract via your own limited company the amount of tax you will pay as a contractor will arise in two different forms, that which you pay through your company and that which you pay personally.
This will in turn be determined by the IR35 status of your contract, such that if you are caught by IR35, you will inevitably suffer higher tax. The financial impact of being caught by IR35 on contractor's tax is severe and you should try to remain outside IR35 if you can.
What taxes does your limited company pay?
Corporation Tax
All limited companies are subject to Corporation Tax at 19%.
If your contract is not caught by IR35, then you will most likely take the traditional route of low salary combined with high dividends. Since dividends can only be paid from company profits, you will need to pay corporation tax at 19% of your net company profit.
If your contract is caught by IR35, then your salary and expenses will be approximately equal to the company’s income, such that the company will make very little net profit and consequently very little, if any, Corporation Tax will be payable.
Corporation Tax is payable 9 months after your year end.
Employer's National Insurance Contributions (NICs)
This is a company cost based on the amount of your gross salary at the rate of 13.8%.
If your contract is caught by IR35, then your salary will be substantially higher as result and consequently the amount of Employer’s National Insurance will be based on the IR35 salary.
If your contract is not caught by IR35, then best advice would be to take a very low salary, potentially avoiding Employer’s National Insurance contributions altogether. No National Insurance contributions are chargeable on company dividends.
Employer's National Insurance is paid monthly.
VAT (Value Added Tax)
If your company is registered for VAT (which the vast majority of contracting companies are), then you will need to charge VAT on your invoices to agencies/clients at the standard rate of 20%.
This money is collected by the company on behalf of HMRC and must be accounted to them on a quarterly basis. You will be able to make claims for input VAT (on your company purchases) by deduction when you make the payment to HMRC.
VAT does not affect your company profit, although it may be possible for the company to register for the “flat rate VAT scheme for small businesses”, which can reduce payments of VAT in certain circumstances.
Personal Taxes
Income Tax
If you are working in an IR35 caught contract, your entire income from the company will be subject to PAYE and will be deducted at source.
If you are not caught by IR35, then only a very small amount of your Income Tax liability will be deducted through PAYE (on the low salary).
On IR35 exempt contracts, you will receive dividends. The dividends are taxed in bands that align with the income tax bands, and the rates are 7.5%, 32.5%, and 38.1%. There is also a Dividend Tax Allowance - which is explained in detail in this other guide to dividend taxes.
Income Tax is paid monthly.
Employee's National Insurance Contribution
If your contract is caught by IR35, then you will suffer Employee’s National Insurance contributions on your salary.
If your contract is not caught by IR35, then you will pay very little, if any, Employee’s National Insurance contributions, since the bulk of your income will be taken by dividends, which do not attract National Insurance contributions of any kind.
Employee's National Insurance Contributions are paid monthly.
Capital Gains Tax
You may be subject to Capital Gains Tax when you close your company and make a capital distribution to yourself as shareholder. Exemptions and reliefs are available through which it may be possible to reduce a substantial capital gain.
[Note: For current rates please see the latest tax tables]