This is our version of the dummy’s guide to the world of the contractor
Background
Being a contractor is very different from being employed. You no longer have a boss! On the other hand, you are completely responsible for your successes and failures.
Contractors are professionals who work under contract for somebody else for a fixed period to help them complete a project. You’re effectively selling your skills and time. Although a contractor may be working for a company, they are not under employment; rather they are working via an agreed contract for a certain period of time or to complete a certain project.
If you are looking to work as a contractor, there are several options to choose from, which include:
- Joining a PAYE Umbrella Company
- Setting up your own Limited Company
- Working as a sole trader
Working via an umbrella company
An Umbrella Company is a great employment option for you if you are new to contracting, or you only have a short term contract, and you want the freedom and flexibility of being a contractor as well as a good deal of support and security.
Becoming an employee of an umbrella company gives you the potential to get more take-home pay than you would through permanent employment by getting paid higher contractor rates, without having to worry about any additional admin, or IR35 and MSC legislation.
If you are interested in our Umbrella service take a look at www.noworriesumbrella.co.uk.
In short –
- You become our employee, with a view to doing a succession of assignments for various agencies / clients in the course of that employment.
- We enter a contract with an agency or an end client, for you to do work for a client.
- You do the work, and complete a timesheet through our online portal.
- We invoice the agency or end client, and receive payment for the work that you have completed.
- Once we have received payment, we pay you directly into your personal bank account.
Working through your own limited company
A limited company is a popular choice for contractors, as it offers the greatest tax savings. But this obviously comes with additional responsibilities and work for you.
A limited company is a legal entity in its own right. It has at least one Director (in the case of No Worries clients, the contractor) and at least one shareholder (again, the client).
A limited company is required to complete Annual Accounts and a Corporation Tax return each year, as well as a Confirmation Statement – but have no fear, we assist with all legal filing requirements.
Your company is required to pay Corporation Tax (currently 19%) on your company’s net profits (i.e. total income less any claimable company expenses). Therefore, any company related expenses you put through your limited company will lower your net profit and therefore lower your company’s corporation tax liability.
As you are the Director and Shareholder of the company you can draw a salary and dividends. We advise most of our clients to set their annual salary at £9,096 for the 2023/24 tax year (pro rata if working only part of the tax year). As a result, you don’t pay any PAYE or NI. The rest of your personal income is derived from dividends. Based on the suggested salary, you can pay yourself up to £4,474 in dividends for this tax year without incurring any additional personal taxes. Any dividends taken over this, and up to £37,700 will be taxed at 8.75%. Dividends paid over the higher earnings threshold are taxed at 33.75% up to the additional rate band.
Please note your personal tax liability will also be affected by any other income you have received from other sources during the same tax year – so if you have any UK earnings from other sources before starting contracting please let us know so we can help you plan for this.
As you will be a director of a limited company, you will also need to submit a personal tax return each year. Again, we can do this for you, or if you prefer to do it on your own, we will provide you with all the information you need, and guidance on what you need to submit.
In summary – Limited Company vs Umbrella
Sole Trader
Working as a sole trader is often considered to be one of the simplest yet riskiest employment options available to contractors or freelancers.
All you need to do to start working as a sole trader is to register as self-employed with HMRC. Similar to running a Limited company, you are then required to complete an annual Self Assessment tax return and arrange your own assignments. You are also responsible for finding a specialist contractor accountant who can handle the additional duties involved in being a sole trader.
This option is therefore most suitable for those willing to take on the extra responsibility and who prefer the independence of being their own boss.
However, there are a number of issues to be aware of. Firstly, as a sole trader you have to find all assignments yourself because of the employment risk involved for agencies (If you don’t pay all your taxes as a sole trader, liability can fall back to the agency).
Secondly, it is often not the most profitable way of working as contractor. You have to pay tax on all your profit, whereas becoming a Limited company director gives you the opportunity to enjoy additional tax benefits. You will also need to make NI contributions.
You also become personally liable for any debts run up by your business, which can mean that your home and other assets are put at risk if things go wrong.
IR35
‘IR35’ is a piece of tax legislation announced in 1999 that took effect from April 2000. Inland Revenue’s intention was to tackle tax and National Insurance (NIC) avoidance schemes through the use of intermediaries, such as a Limited Company.
No Worries has found that issues surrounding IR35 can be successfully mitigated by using a combination of the right advice and having the right working practices in place.
The best approach they can take to show they operate ‘outside of IR35’ is to be seen doing business on their own account. There are a number of ways to do this and we recommend that you have a full review done by an IR35 specialists.
(1) The contractor needs to present (and to continue to present) an overall picture of a person carrying on business of their own account – ie ‘being in business’
(2) The contractor needs to avoid the trap of slipping into the into becoming ‘part and parcel’ of the client’s organization – ie a disguised employee
If the contract and working practice is deemed ‘caught’ by IR35, the contractor will lose the ability to take advantage of the tax effectiveness of working through a limited company, and must pay the normal PAYE tax and NIC usually only reserved for permanent employees. There are some expenses they can still offset against their company income, but the advantage of operating through a limited company is essentially lost.
Agency Worker’s Regulations (AWR)
The Agency Workers Regulations (AWR) came into force on 1st October 2011 to protect both contractors working PAYE through an agency, and also contractors working through an agency and using the services of an Umbrella to get paid. The regulations apply to “workers with a contract of employment or employment relationship with a temporary work agency who are assigned to user undertakings to work temporarily under their supervision and direction.”
The regulations are a big shake-up for the recruitment business and for contracting work in general. Essentially the regulations allow for contractors to gain the same employment rights as the full-time employees that they sit alongside.
However, the AWR does not affect contractors working through their own limited company and who are outside IR35.
For our clients who mostly work through their own limited company’s, the implementation of the AWR will result in no real changes. However, one area that will change will be your client’s motivation to ensure you continue to operate outside of IR35. Clients engage the services to contractors to fulfil short term needs without having to comply with the onerous conditions of employment. Its great having a flexible workforce that can come in, perform specific tasks, and then leave again with no long lasting effects of sick pay, holiday pay, redundancy pay etc. Under AWR, clients will want to ensure their ltd company contractors continue to work outside of IR35, to ensure AWR will not apply. So after 01 Oct 2011, both the contractor, and the end-client will want to ensure the working relationship is compliant with IR35.
For temp contractors who fall within AWR (so either work through an Umbrella company, or work PAYE through their recruitment agency), from 01 Oct 2011 they will having the following rights;
From Day 1:
– Be informed of any relevant vacancies within a hirer’s organisation; – Access to collective facilities and amenities provided by the hirer.
Week 12 Onwards:
– The right to be treated, in terms of pay and employment conditions, as if they had been hired directly into that role at the start of the 12 week period
More Information
For those wanting more information, take a look at the full Guidance for Agency Workers Regulations published by the Department for Business Innovative and Skills.
Managed Service Company Legislation (MSC)
Alongside being in business on your own account – either as a sole trader or using a limited company, or using an umbrella company there was, until 2007, popular alternative schemes in the form of Managed Service Companies or Composite Companies. This form of company structure placed contractors into groups of shareholders in a corporation owned and run by the service provider, providing contractors with the tax benefits of working through a limited company without the overall responsibility.
HMRC announced legislation to remove the tax advantage offered by using such “MSC” schemes in December 2006. The following excerpt lays down the intentions of the legislation:
“The Government is taking action to tackle Managed Service Company (MSC) schemes which are used to avoid paying employed levels of tax and NICs. Income received by workers in MSCs in relation to services provided through the MSC will be subject to employed levels of tax and NICs, with the MSC obliged to operate Pay As You Earn (PAYE) and deduct tax and Class 1 NICs on that income – and the rules for tax relief for travel expenses will be the same as for other employed workers. The Government will also address the problem of MSCs escaping payment of tax and NICs due by allowing the recovery of these debts from appropriate third parties.”
After a period of consultation, managed service company legislation became law in April 2007 with some additional aspects coming into force in August 07 and in January 2008.
Managed Service Companies are defined by the HMRC as those that provide the services of individuals to third party clients and are “involved” such as, benefiting financially from the provision of those services to clients, influencing or controlling the provision of services or the way in which the payment for services is made. (Thereby demonstrating the contractor is not in business on their own account and with full responsibility and control over their business.)
A summary of important terminology –
24 Month Rule – You can claim travel and accommodation expenses if you are working at a temporary workplace. HMRC defines a temporary workplace as somewhere where your attendance lasts no longer than 24 months. For example, if you signed a 36 month contract, this would be considered your permanent place of work and no travel or accommodation expenses could be claimed.
Anti-Bribery Act – This is a piece of legislation that came into force in July 2011 with the aim of modernising bribery law.
Auto-Enrolment – Auto-Enrolment is a piece of legislation that requires employers to register all eligible employees on a company pension scheme.
Corporation Tax – Corporation tax is tax that is due on the profits (turnover – expenses) of a limited company.
Employment Agencies Act – This piece of legislation was created to safeguard work seekers, hirers and the needs of the recruitment industry.
Employer’s Liability Insurance – By law, all employers in the UK must have at least £5million employer’s liability insurance to ensure that they can always compensate employees who have to make a valid work related claim.
Flat Rate VAT – This is a scheme that has been in operation since 2002 and aims to reduce the cost of fulfilling your VAT obligations. The VAT due to the HMRC is calculated as a flat percentage of your total turnover (Inc VAT) for the quarter.
Holiday Pay – Most workers in the UK are entitled to a minimum amount of paid holiday each year, known as statutory holiday. This currently stands at 5.6 weeks per year, your contract of employment may offer more than this amount but by law it cannot be less.
Income Tax – Income tax is tax charged on your earnings (less any personal allowances you are entitled to).
Limited Liability – Any debt is that of the company and the director(s) cannot be personally liable.
National Insurance – National insurance contributions are deducted from your salary or paid via direct debit if you aren’t subject to PAYE. These payments entitle you to certain state benefits such as the NHS and State Pension.
National Minimum Wage – National Minimum Wage is the minimum amount that someone can be paid per hour in the UK. The rates vary according to age, see https://www.gov.uk/national-minimum-wage-rates
PAYE – PAYE stands for Pay As You Earn. It is a system where your employer deducts income tax from your taxable gross earnings. The amount taxed will depend on your gross salary.
Professional Indemnity Insurance – This is a type of insurance that is used to protect both companies and their employees from claims that may be made by third parties due to negligence or mistakes that have occurred during the provision of services.
Public Liability Insurance – Public liability insurance is used to protect both companies and their workers from claims made by members of the public who have sustained an injury or had some form of damage caused to them. There is no law that requires you to have public liability insurance but it is highly recommended if your business means that you regularly come into close contact with the general public.
RTI (Real Time Information) – As part of RTI, employers will need to submit PAYE information to HMRC each time they pay their employees, rather than just once at the end of the payroll year.
Self-Assessment Tax Returns – If you are self-employed or a director of a limited company, you will need to complete a self-assessment tax return each year to notify HMRC of your earnings. Returns, and payment of any tax due, need to be made by 31 January of each year.
Self-Employed Tax – If you are working as a sole trader you will need to pay self-employed tax. The amount of tax you owe will be calculated through submission of your self-assessment tax return.
Sole Trader – A sole trader is someone who is registered as self-employed and is not the owner of a limited company. Sole traders have unlimited liability and need to fill out a self-assessment tax return each year.
Statutory Adoption Pay – If you have adopted a child by an adoption agency, you could be entitled to 52 weeks of statutory adoption leave. This includes 26 weeks of ordinary adoption leave and then you can take an additional 26 weeks should you require it. To qualify, you need to have worked continuously for 26 weeks for your current employer and provide evidence that you have adopted a child.
Statutory Maternity Leave – You have the right to 26 weeks of ordinary maternity leave and 26 weeks of additional maternity leave. To qualify you must be an employee and give your employer the correct notice.
Statutory Paternity Leave – To qualify for statutory paternity leave you need to have been with your current employer for at least 26 weeks and be taking time off to support the mother of the baby. Paternity leave usually lasts one to two weeks.
Statutory Sick Pay (SSP) – If you are too ill to work, you may be entitled to Statutory Sick Pay. The standard rate is £81.60 per week and is paid for up to 28 weeks. You’ll usually receive SSP if you are sick for at least four days in a row and have weekly earnings in excess of £102 per week.
Swedish Derogation – A clause in the AWR that means the AWR rights to equal pay of an agency worker no longer exist when agency workers are employed on a permanent basis by their Umbrella Company or temporary work agency and receive pay in-between assignments.
Temporary Workplace Expenses – As a temporary worker, you are entitled to claim certain business expenses that you may incur throughout the day e.g. your travel to and from work. A temporary workplace is a place of work that you need to attend for a limited period of time.
Umbrella Company – An Umbrella Company acts as an employer to contractors who are working on temporary contracts.
Unique Tax Reference (UTR) – A UTR number is a number that you are presented with when you register as self-employed with HMRC. You will need your UTR when you complete a tax return and communicate with HMRC as it’s their way of identifying you. To register see –https://www.gov.uk/log-in-file-self-assessment-tax-return/register-if-youre-not-self-employed
VAT – VAT stands for Value Added Tax and it is a tax that is charged on the majority of goods and services in the UK and for some goods and services imported from other countries. As of 2014, once your revenue is greater than £81,000 you are required to register for VAT and start charging VAT at the rate of 20%.
Working Time Regulations – These are regulations that give EU workers the right to a minimum number of days holiday, paid breaks and the right to a certain amount of rest. Furthermore, workers have the right to work no more than 48 hours each week or undertake excessive night work.