Do you have a strong desire to be your own boss?
Have you explored its financial benefits? Or perhaps you want to develop your skills, but your current job can’t offer this.
If this describes you, contracting might be the right path to take. You undoubtedly have a lot of questions.
We have compiled this detailed guide on what a contractor is to dispel any myths and assist you in preparing for the journey ahead.
We at 123Financials are glad to say that we take a unique approach to accounting.
When we first start working together, we like to schedule a face-to-face or Zoom meeting; we will come to you to discuss your requirements in more detail. Do not worry; we aren’t scary and will try not to bore you too much by discussing tax!
We know that every contractor has different needs. But one thing that never changes is our promise; we ensure you receive a personalised, professional, and specialist service.
Hire contractor accountants
Work with a UK-based accountant for tax, accounting, payroll, & EIS/ SEIS needs.
Table of contents
● Reasons why to choose to contract?
● Pros and cons
● Lets talk numbers
● How to operate as a contractor legally?
● Setting up a Limited Company
● Expenses management
● Responsibilities of running a LTD
● VAT or not?
● IR35
● FAQ’s
● 5 CV tips for contractors – you’re hired!
● Glossary of terms
Reasons why to choose to contract?
Individuals take the move to contract for several reasons. They could:
- Be aiming to take the next step in their career
- Want more flexibility
- Higher earning potential
Whatever the reason, leaping contracting is much easier than you may think. To help you grasp what to expect, we’ve identified the advantages and disadvantages of contracting through an Ltd company.
Pros and cons
Pros
- You are no longer an employee. You are your own boss.
- As a contractor, you can expect to make more money (in some sectors, this can be 2-3 times as much as your employee counterparts).
- You can claim more costs related to operating as a contractor. You have your own business and the expenses that come with this.
- You have better control over who you work for, where, and when
- Greater possibilities to increase your knowledge and skills.
- You can take prolonged breaks during contracts which might work better for your personal situation.
- On each project, you get to work with a different group of people (avoiding the office politics that come with regular employment).
- It is more beneficial if you don’t spend all you earn. A sizeable chunk is available to invest.
Cons
- Less job stability (but the same can be true about regular employment as well).
- The tax benefits of contracting are eroding after an increase in corporate tax rates, dividend tax rates, and reduced dividend allowance.
- You won’t get paid if you don’t work.
- You must find your next contract, which implies being proactive with job-hunting.
- You do not receive sick pay if you are ill (but critical illness insurance is available).
- You do not receive holiday pay if you want to take a vacation.
- You aren’t entitled to get company benefits, such as pension contributions
- You might face a longer commute for the right contract.
Switching from regular employment to contracting is not a decision that should be made on a whim. However, in most circumstances, the benefits outweigh the drawbacks.
Let’s talk numbers
What are the qualities of being a successful contractor? We certainly agree that it takes persistence, passion, and effort. Working long-term as a contractor also includes earning enough money to live off.
What can you expect to earn?
The contracting community is large. It covers various topics, including IT, accounting, healthcare, engineering, construction, etc.
Depending on the industry and location, a first-time contractor can expect to charge a daily rate between £300 and £2,000.
Contractors with specialised knowledge are in greater demand and can thus charge more. For example, some cybersecurity contractors charge more than £800 a day.
Similarly, contractors in London can charge more than those in other regions of the country simply due to the higher demand.
As a specialist contractor working through a limited company, you can expect to make between 70% – 80% of your contract value after paying any tax liabilities, VAT, and accountancy fees.
How to operate as a contractor legally?
If you choose to become a contractor, there are various ways you can operate.
The two primary options are through an umbrella company or your limited company.
What is an Umbrella Company?
First of all, it’s got nothing to do with umbrellas!
An umbrella company is a corporation that acts as an employer to agency contractors that are employed on a fixed-term contract assignment.
When you work via an umbrella company, you essentially join their staff, and they ‘contract out your services to end customers, typically via a recruitment agency.
A timesheet must be presented monthly to the umbrella company, which will then bill the client or agency.
The umbrella company will pay you minus deductions for NIC and PAYE and their charges.
What is a Limited Company?
A limited company (or personal service business, as it is frequently referred to) is the most common and tax-efficient way to conduct business as a contractor.
In the process of establishing a limited company, you become the director.
This implies that you are accountable to follow the laws for running the company. There are specific obligations that come with this. These are further covered in detail later in the guide.
The limited company is lawfully a separate entity from yourself. So, any contract is formed between the client and the limited company, not between you and the client.
| Limited Company | Umbrella Company |
| Suitable for | |
| Contractors who plan to make contracting their long-term career choice | First-time contractors who want the security that employment offers |
| Contractors earning more than £25,000 p.a. | Contractors who earn less than £25,000 p.a. |
| Contractors who work outside of IR35 | If you’re only going to be contracting for a short time. |
| Contractors who want greater financial control | Contractors who do not want to manage the administrative duties associated with operating a limited company. |
| Contractors who want to run their own business and be their own boss | Contractors working inside IR35 |
| Contractors who intend to work in the most tax-efficient way possible | |
| Advantages | |
| In many cases, it is the most tax-efficient way to operate. | |
| Displays a professional image | |
| You have total control over the company. | The contractor receives full employment benefits and rights: holiday pay, sick pay, maternity/paternity pay. |
| Higher take-home pay. | The Umbrella Company manages National Insurance and Tax obligations. |
| Can claim for business expenses. | No paperwork – contractor only has to submit a timesheet. |
| Select how you want to get paid – usually a mixture of dividends and a small salary. | |
| Can join the Flat Rate VAT Scheme. | |
Setting up a Limited Company
If you are thinking of contracting for the long term, setting up your own limited company is one of the best ways to operate.
Starting your own business may seem intimidating and hard, so we’ve outlined the procedures that describe what is involved in setting up a limited company.
1. Choose a business name
Every limited company requires a unique name. Ideally, the company name should represent what your firm does.
Since you might use your business name for marketing, it’s a good idea to pick a name that is simple to remember and spell for your business. Before you incorporate the company, it is also worthwhile to verify that the company name is available as a web domain in case you decide to build a website for your firm. Once your firm is incorporated, you must include LTD or Limited at the end.
2. Appoint a director and shareholder
A limited business should have at least one director, probably yourself. The director is tasked with managing the business in accordance with all applicable legal procedures and with submitting all required papers to HMRC.
Ownership of the firm is issued through shares. As the director of the firm, you will probably be the major shareholder as well unless you choose to share ownership with another person, like your spouse.
3. Registering the company
Once you’ve selected a company name, you can incorporate the business by submitting a registrating to Companies House. You can do this online or through the mail. You will be provided with a Certificate of Incorporation after the incorporation is finished, which usually takes 24 hours.
You can also allow a third party to incorporate the business on your behalf. As a part of our monthly accounting packages, we provide this service for free. Please visit our website for further details.
4. Informing HMRC
You must let HMRC know that you have incorporated a limited company. This must be done within three months of beginning any company activity (for instance, advertising the business).
HMRC will ask for the following:
- Business name
- Company’s registered number
- Company’s start date
- Data about the kind of business you plan to run
- Business’s address
HMRC also requires you to know the date to which you are submitting your first set of accounts.
After notifying HMRC, they will forward you by mail a Unique Tax Reference number (UTR). It’s critical to keep this safe.
You will require it to set up an online account to pay Corporation Tax and submit a tax return online.
5. Opening a business account
It’s essential to understand that the limited company’s finances are separate from your personal finances. As the director of a limited business, you are legally responsible for opening a separate business bank account for the firm.
There are several alternatives available to choose from. To find the accountant that can give you the best value, research is critical.
Some things to consider include:
- Is there an internet banking option?
- Can you talk to an account manager, if necessary?
- What transaction expenses are applicable?
- What interest rates are charged?
6. Find a great accountant
In the decades of years, we have been in business and have spoken with thousands of contractors. It’s been a regular practice for us to work with clients from other accountants – our clients are usually surprised at how little tax planning was done earlier.
An expert contractor accountant can not only help you run your business in the most tax-efficient way, but they can also save you time and reduce the stress of being your own boss. We are pleased that most of our new customers come from recommendations. After you join the 123Financials Accounting Family, one of our partners will come to meet you to go through everything in further detail.
Expenses management
Explaining expenses
What is a business expense? It is made ‘exclusively and wholly for your business, as these can deduct from income to reduce your taxable profit and, thus, tax bill.
As a contractor operating through a limited company (outside of IR35), you might be able to claim for things like those in the list below.
- Company bank charges and interest
- Clothing (protective work clothing or branded uniform. T-shirts and jeans aren’t allowed, we’re afraid!)
- Pension contributions
- Accountancy charges
- Computer equipment
- Business travel and hotel
- Branded stationery (business cards, letterheads, etc.) and postage
- Internet and phone costs
- Software
- Business entertainment
- Equipment for business purposes
- Motoring charges
- Technical journals and books
- Some professional subscriptions
- Use of a part of your property as an office
What’s not allowed
If it is not meant for the sole and exclusive use of the company, the rule of thumb states that it is not an allowable business expense.
Examples of what is NOT permitted include medical expenses, gym membership, parking fines (ensure you put enough money in the meter!) and speeding tickets.
If such expenses are incurred through the company, you might end up paying more in taxes than you saved as a “benefit in kind.”
How to claim business expenses
If you paid for it with a business account, you should keep a record of the purchase as proof. This can be in the form of a receipt.
If you made the purchase with your personal account, you would need to transfer the amount from your firm’s account to your personal account monthly.
You must keep all receipts for at least six years to prove the purchase was made. This is to protect yourself in the unlikely situation of a tax inspection.
Responsibilities of running a LTD
Your responsibilities
Running a limited company entails several responsibilities. Don’t worry; these responsibilities aren’t challenging to understand, but you must know them. In addition, a great accountant (like ourselves) can assist you with these.
Annual accounts
These must be submitted to Companies House on an annual basis. This is usually done within 9 months of the end of the year date.
Confirmation statement
Submitted to Companies House on an annual basis. It gives them current information about your limited company, such as director and shareholder information, and the company address. Companies House charges a fee of £13 for this.
Real-Time Information (RTI) payroll returns
Information about an employee’s salary and associated deductions must be sent to HMRC before or at the same time as the payment is made.
Corporation tax returns
This must be submitted to HMRC along with a set of year-end accounts. It is advisable to submit this along with your documentation to Companies House.
VAT returns
This can be done either online with HMRC or through a third party. We can assist you with this. Payment can be made through BACS or direct debit.
Paying PAYE and NIC
If you run the payroll monthly, you must inform HMRC of any PAYE and NIC payments due via RTI.
A bank transfer is the preferred method of payment. Most Directors would receive a salary as well as dividends from their company.
Online Self Assessment and payment of tax liabilities
Self-assessment tax returns must be filed, and any tax liability should be paid in full by midnight on 31 January, following the tax year-end.
There are penalties and fines for late payment and submission. In addition, any outstanding amount will be subject to interest.
This can quickly add up, so completing it on time is critical. This can be done through HMRC’s online services (if you have registered). A third party can also do this for you. We provide this service as part of our monthly accounting packages.
VAT or not?
The most commonly asked question is, “Do I need to be VAT registered?”
The answer is straightforward. A business must register for VAT if, at the end of any month, its taxable turnover for any consecutive 12-month period exceeds the VAT threshold (£85,000 from 1 April 2017).
If your turnover is below the threshold, but you anticipate receiving a large income payment in the next 30 days that will push you over the threshold, you must register immediately.
Even if you do not anticipate exceeding the VAT threshold, you can register for VAT voluntarily. These are some of the reasons for it:
- In some professions and industries, it is expected that businesses are VAT registered.
- It appears more professional to be VAT registered.
- If you make a lot of business purchases, being VAT registered may be beneficial because you might be able to claim back the VAT (only if you are eligible)
If you decide to register for VAT, you might find the Flat Rate Scheme (FRS) useful. This scheme is open to small businesses with a VAT turnover of £150,000 or less than that (excluding VAT).
This scheme enables you to charge 20% VAT to the company you are contracting, then pay it back to HMRC at a low rate (based on which trade sector your company falls into).
You can benefit from cash accounting by becoming VAT registered. Cash accounting means you only pay VAT to HMRC once you’ve received it from your client.This can be highly beneficial to a company’s cash flow. With accrual accounting, you might pay HMRC depending on when the invoice was raised.
IR35: In or Out
What is it all about?
Ask any contractor what one word makes them fear, and the vast majority will say ‘IR35.’
IR35 is a piece of legislation that was passed in April 2000. Its sole purpose is to protect against what HMRC calls “disguised employment.”
A simple example would be an employee leaving their job on a Friday and returning the following Monday as a contractor. They would essentially be doing the same job as before, but with the added ‘benefits’ of working through their own limited company.
Determining IR35 status
Sadly, it is not as simple as saying, “I work through a limited company and am a contractor.” As a result, I must be exempt from IR35. HMRC is cracking down hard on disguised employment, particularly in the public sector.
New rules were implemented in April 2017, which saw the liability for determining the IR35 status of a contract shift away from the contractor and towards “any third party which is closest to the limited company contractor” – in other words, the organisation that pays you.
Effect on income
If your contract is deemed to be within IR35, you are effectively classified as an employee of the business.
You should pay the full tax and National Insurance contributions from your earnings. Therefore, reducing the advantage of working through a limited company.
You also have a reduced allowance expense, which means you can only claim tax relief for certain items.
The rules governing IR35 legislation are incredibly complicated. Most genuine contractor contracts are acceptable, but we recommend that you consult with an expert before signing any contract to determine whether the contract will place you inside or outside of IR35.
FAQ’s
Some people may advise you against becoming a contractor, believing it is risky.
We thought we’d dispel four common contracting myths to assist you in determining if contracting is the right choice for you.
Is contractor income less than permanent income?
False: The average contractor can anticipate earning between £300 and £500 per day.
Contractors in niche industries and major cities such as London can earn significantly more.
Yes, there may be times when you are not working (for example, between contracts), but you can reduce risk by proactively finding contracts and building up cash in the business.
Can you go back to ‘perm’ once you become a contractor?
False: Contracting has no stigma attached to it. If you decide that contracting isn’t for you and want to return to full-time employment, it’s almost unheard of for an employer to turn you down for a position because you were a contractor.
Furthermore, demonstrating that you are adaptable and can take ownership of projects is a plus for any employer. We’ve discovered that most contractors would instead not return to permanent work!
Will contracting take over my life?
False: Being a contractor allows you to work for whomever and whenever you want. A few contractors work hard on a project and then decide to take an extended leave after the contract is completed. They could spend this time traveling or with their family. Employees do not have this luxury. They are usually given a set number of leaves days per year that they cannot exceed
Will my skills become outdated?
False: One common myth about contracting is that your expertise will become outdated after a year or so. This may be a problem for contractors in some industries, but it can also happen to permanent employees. You won’t face this problem if you keep your skills up to date.
5 CV tips for contractors – you’re hired!
The quality of your CV largely determines your chances of being hired as a contractor.
A recruiter or employer will look at your CV for about 20 seconds. As a result, your CV must be able to impress right away.
If you haven’t looked at your CV in a while or don’t have one, these tips will help you stand out.
1. Tailor your CV
You must tailor your CV to the role for which you’re applying. Contractors usually have three or four versions of their CVs for different roles.
A recruiter or hiring manager will quickly recognise a generalised CV. If it is, it will almost certainly end up in the trash.
2. Make it personable
As previously stated, someone usually looks at your CV for 20 seconds or less, so the first impression is critical.
If your CV includes spelling or grammar errors, it may quickly be discarded.
If you are having difficulty putting together your CV, it may be worthwhile to have it professionally written.
If you prefer to do it yourself, have one or two people review it for errors.
3. Length matters
A CV should not be two pages long (A4 size). As a contractor, however, you may have a broader range of work experience. In that case, increasing the length of your CV to four pages is acceptable. However, be careful not to exceed this limit; the reader may consider it too long and discard it.
4. Make it easy to read
A recruiter or hiring manager does not have the time to read through reams of information.
Break up your CV with sub-headers and bullet points to make it easier to read. It may be tempting to create your CV more interesting by presenting it in a unique format, such as an interactive presentation or a web file.
However, most people, particularly recruiters, still prefer to receive a CV in the form of a word document or a pdf file.
5. CV Layout
First page:
Personal information: Name, phone number, email address, and postal address.
Profile: A brief summary (three to four lines) of who you are, what you are looking for, what you do and your core skills.
Expertise: Utilising bullet points to list your areas of expertise that correspond to the contract’s requirements. Expand on these areas by relating them back to numbers. For example, how much money you saved for the business over a specific time period.
Skills: List your skills (or key technological skills) and describe how they can benefit the company.
Second page:
Work experience: List your employer’s name, the date or time frame you worked for them, and a brief detailed description of the project that you worked on
Additional information: Information on languages spoken or the type of driver’s license held. References: mention that they will be available at the interview.
A contractor’s CV differs from a standard CV in that the employer is more keen on your skills and expertise and how they can help the business instead of your previous work experience; following the layout outlined above increases your chances of being offered your ideal contract.
Hire contractor accountants
Work with a UK-based accountant for tax, accounting, payroll, & EIS/ SEIS needs.
Glossary of terms
Annual financial accounts
Annual Financial Accounts, are also known as Annual Accounts or Company Accounts. They include a balance sheet, a directors’ report and an income statement. Annual Financial Accounts must be filed with Companies House & HM Revenue & Customs (HMRC)
Companies House
This is the UK Registrar of Companies, where your limited company must be registered. Companies House requires each registered company to file Annual Financial Accounts and Confirmation Statements.
Confirmation statements
Confirmation statements must be filed with Companies House on an annual basis. It lists the directors, registered office, secretaries, shareholding and share capital.
Corporation Tax
Corporation Tax is a tax levied on the profits of businesses. Corporation tax is calculated as a percentage of profits at the end of the business year.
Dividends
Dividends refer to payments made by a business to its shareholders from business profits.
Payroll Year-End Returns (FPS)
Each tax year (from 6 April to 5 April), all businesses that pay salaries to their employees are required to submit a final payroll return by 19 April to “close off” the year’s PAYE (pay as you earn or salary tax) submissions to HMRC.
Expenses
Expenses incurred while carrying out company business; they are entirely and solely for the company’s benefit and have been paid for personally. These expenses can be claimed back from the business.
Expenses paid by the business reduce the business profit and corporation tax liability.
Flat Rate Scheme (FRS)
A scheme designed to make VAT compliance easier for small businesses. Businesses can charge standard VAT (20%) and pay it back to HMRC at a lower rate, depending on their trade industry.
HM Revenue & Customs
HM Revenue & Customs (HMRC), also known as “Her Majesty’s Revenue and Customs”, is the government body liable for the collection of taxes.
IR35
IR35 is a piece of legislation that enables HMRC to gather additional payments from contractors as an employee in all but name.
Limited company
It is a separate legal entity incorporated with Companies House.
National Insurance
NI (National Insurance) refers to the contributions made depending on profit or earnings.
PAYE
PAYE (Pay as You Earn) refers to a tax on earnings deducted at source by employers on behalf of HMRC.
Real-Time Information payroll returns
RTI (Real Time Information payroll returns) are monthly payroll returns that require to be submitted to HMRC declaring what wages your firm has paid yourself and/or your employees.
Turnover
Your company’s turnover refers to the total sum invoiced by your business (excluding VAT).
VAT
VAT (Value Added Tax) is an end-user tax applicable to products or services. The output VAT applies to invoices and is collected on behalf of HMRC.
Input VAT is the amount paid to suppliers. The difference in output VAT less input VAT must be paid to HMRC quarterly.
