Dear Contractor Doctor,
I am an engineer and although throughout my career to date I have always been a permanent employee of various engineering consultants, I’ve been offered the opportunity to work on a contract basis on a year-long project.
Despite researching all the different trading options that will maximise my net income during the project, such as a sole tradership, contractor limited company, umbrella company and the various offshore tax solution options, I’m still not clear which would be the most tax-efficient for my personal circumstances.
Is it worth starting a limited company for one contract?
Contractor Doctor says:
Contracting through a limited company can be a tax-efficient trading option even over short periods of time, but the trading option that will deliver the greatest return versus cost, risk and other factors depends on each contractor’s individual circumstances.
Before making a choice, contractors need to consider issues such as IR35 status, their longer-term career strategy, whether they have a spouse or partner with unused personal allowances and the nature of the contract itself.
Also, as in Sarah’s case, if the contractor is looking for a trading solution for just a single contract, even if it is a lengthy contract outside of IR35, different expenses rules from HMRC kick in, potentially leaving a contractor seriously financially disadvantaged.
Determine IR35 status first
If contracting for the first time, before they choose a trading option contractors should always have their contract reviewed by an IR35 expert. The expert will consider IR35 factors, and determine whether their contract may be inside or outside IR35.
Should the contract be judged to have a high risk of being found inside IR35, it is unlikely that a limited company would be a tax-efficient trading option for a single, short-term contract.
This is because, if a contract is caught by IR35, the contractor’s fee income less a 5% allowance for expenses is deemed to be employment income and taxed accordingly, thereby negating the tax benefits of contracting through a contractor limited company.
Contractors can check if their contract is likely to attract unwelcome attention from HMRC by using Contractor Calculator’s free online IR35 test. They can also calculate potential income inside and outside IR35 by using Contractor Calculator’s range of free interactive income calculators.
Single employment changes expenses rules
Because Sarah’s contract is likely to be classified as a single employment, she may find that HMRC rules won’t allow her to claim back travel and subsistence expenses through her limited company and offset these expenses against tax.
Normally, the so-called ‘24-month rule’ would apply to contractor limited company contractors with an office and trading address at home, and who work daily at a client’s site that is classed as a temporary workplace. Under this arrangement, contractors can claim travel and subsistence expenses. But according to HMRC’s rules, if the entire duration of the employment is at that site, the client’s site does not qualify as a temporary workplace and the 24-month rule is overridden.
So, if a contractor specifically creates a new limited company for a single 12-month contract with a single client at one location for the duration of the entire contract, and they then close the company immediately after the contract ends, then they can’t claim travel and subsistence expenses.
Limited companies are longer term-trading solutions
Although to set up a contractor limited company in the UK can be very easy and inexpensive, running it comes with duties and responsibilities for its directors, plus accountancy and administration costs that are required to comply with financial reporting and HMRC requirements.
Unless the contract value is very high and the expenses savings are substantial, then in most cases the cost, including the time cost, of running a limited company for only a short time will outweigh the tax savings.
However, if the contractor is a higher rate taxpayer and has a spouse who does not use all of their personal tax allowances, then it could be tax efficient to incorporate the company with the spouse as a shareholder and director. The contractor could then potentially split the company’s dividends with their spouse and save tax by using the spouse’s personal allowances.
Contractors considering this route should be aware of the settlements legislation (formerly known as Section 660) and ensure they satisfy the conditions for an exemption.
Crunch the numbers
For most contractors considering a short-term career in contracting with a single contract, a contractor umbrella solution provider is likely to be the most tax-efficient option, particularly if the contract is inside IR35.
But because every contractor’s personal circumstances are different, in some cases the contractor could benefit from incorporating a limited company for a single contract. Contractor Calculator’s range of interactive online calculators will provide contractors with a good idea of which route is financially best for them.