Contractor Accountants - VAT, PAYE & Corporation Tax
By becoming VAT registered, contractors working through their own limited company can potentially save a significant amount of money.
VAT, or Value Added Tax, is a sales tax added to the price of most goods and services in the UK. Many goods and services attract VAT, however many financial services and items such as books and journals are zero-rated.
Any limited company, which has a gross income of over £77,000 per year, known as the VAT threshold, must register for VAT or risk of being fined. Any contractor however whose company is turning over less than the threshold can also voluntarily register for VAT, and for many contractors this is well worth considering.
As part of our service to contractors EAFS will process your VAT returns for you - all you need to do is send in your paperwork and we’ll do all the leg work for you including filing your on-line return. All you need to do is just check it and pay the VAT via electronic transfer, or via a direct debit set up to pay automatically when the return is filed.
Contractor invoices – output tax
Output tax relates to the VAT charged on goods & services. As a contractor registered for VAT when you prepare and issue your invoices you must add VAT at the rate set for that financial year, currently set at 20% for the financial year ending 2012/13. For example when invoicing your client or agency for five days work set at a daily rate of £500 per day, the invoice would be set out as follows.
5 days @ £500 per day = £2,500
VAT at 20% the calculation is 2,500 * 20% = £500
Total including VAT the calculation is 2,500 + 500 = £3,000
At the end of every quarter you, the contractor must add up all the output tax you have charged your clients, take away any input tax (which is described next) and pay the balance to HMRC using the VAT on-line returns system.
Contractor purchases – input tax
The opposite is also true, whenever your contracting limited company buys goods and services, the cost of these purchases will include someone else’s VAT, charged at 20%, which to you, the contractor is called input tax.
So if you buy an iPad for £600 and the VAT has been charged by the supplier at the rate set for that financial year, which is currently set at 20%, then you, the contractor can offset the VAT on this purchase, against any VAT you have charged their clients,.
For example, the VAT element of the laptop is £600/120*20 = £100.00, which means the price of the laptop excluding VAT is £500.00
The VAT return
As a contractor you have to account for VAT every quarter. It is possible to accrue VAT and pay it on an annualised basis, but this is not recommended as the administration burden and cash flow implications do not suit most contractors.
There is also a flat rate VAT scheme, which may suit some contractors with a certain level and frequency of expenditure, and it is recommended that contractors consult EAFS before considering changing to the flat rate VAT scheme.
In order to complete the VAT returns, contractors must add together all the output tax, which is all the VAT they have charged their agency or client in the quarter.
Let’s stay with the example we had earlier, and assuming that the contractor has billed 5 days @ £500 per day, although most contractors would have around 90 days of work completed in this period and be billing many thousands, with a correspondingly higher VAT total.
The output tax in this invoice, from the previous calculation above, is £500 (5 x 400 = 2,000, then £2,500 * 20% = £500 output VAT).
The contractor bought a iPad in that quarter for £600, again as above. The input tax on the purchase of the laptop is £100.00 (£600/120*20 = £100.00 input VAT).
The net VAT payable by the contractor’s limited company to HMRC is the output tax minus the input tax, which works out at £500 – £100 = £400
Imagine how much VAT can be saved when you add up the cost of all your company purchases, including office supplies and equipment. This can ammount to a considerable saving and is well worth the time spent collecting VAT receipts and completing VAT returns.
PAYE (Pay As You Earn)
PAYE is UK term relating to a tax deduction for the Government made by the employer direct from employees’ earnings. It is an abbreviation for “Pay as You Earn”. PAYE therefore is a automatic tax deduction that has to be made from your pay if you are an employee.
PAYE is an automatic deduction from your gross pay by your employer that is then paid over by them direct to the Inland Revenue (HMRC). If your only earnings in a tax year are from your wages it helps ensure your tax has been paid in full (and therefore removes the worry or stress of having to do tax returns or save up for your tax bill).
PAYE thresholds (above which tax is payable) are: £156 per week or £675 per month. (Personal Allowance £8,105).
Tax Rates that apply:
- 20% up to £34,370
- 40% between £34,371 and £150,000
- 50% above £150,000
PAYE for Contractors
IR35 was introduced to ensure the majority of contractors pay tax along similar lines to employees performing similar roles at similar hourly rates. Prior to the release of IR35 contractors would pay significantly less tax by paying themselves through intermediaries such as Partnerships or Personal Service Companies.
Contractors outside of IR35 pay a combination of salary of which PAYE is payable and dividends, which attract less tax than salary extraction but are not tax deductible for Corporation tax purposes. EAFS accountants can advise on the optimal structure of salary and dividend.
If a contractor is caught by IR35 they have to have tax (PAYE and National Insurance Contributions (NIC’s)) deducted from their pay as “deemed employees”.
The most important tax liability that applies to limited companies is Corporation Tax. This is a levy on your company's profits, that is to say the money that is left over once your business expenses, including your salary, have been deducted from your turnover. Trading profits, profits from investments and capital gains are all subject to Corporation Tax.
When you start up as a limited company contractor, then you will have to assess your business each year for corporation tax. This is a tax on your company's profits. You have to work out your own tax liability, pay that tax, and ensure you deliver all required information to Her Majesty's Revenue & Customs (HMRC) on time or face a substantial fine.
Of course you won't have to physically do it yourself; getting this right is one of the main reasons you need a specialist contractor accountant such as EAFS. As with all tax affairs, if you get it wrong or send required information late, you will be penalised - sometimes with a fine.
Corporation Tax Rates for Contractors
There are two rates of corporation tax set according to the level of profits you make. In the 2012/13-tax year, you pay 20% on profits of up to £300,000. Known as small profits rate this will apply to almost all IT contractor companies.
The main rate is 24% on profits of £1.5 million and above. Companies that make profits between £300,000 and £1.5 million pay marginal relief on the level of profits between the two rates.