2020/21 Tax Rates and Allowances
This page contains all of the personal income tax changes which were published on the gov.uk site on Fri 28 Feb 2020. These rates come into effect at the start of the new tax year, on April 6th 2020.
You may be looking to work independently, freeing yourself of the company mantle. You’ll no doubt have seen colleagues moving from full-time employment to offering their expertise on a freelance or contract basis or as a micro-agency. You may have heard about dark mysterious ways of paying less tax. And you may have heard that HMRC are now being much stricter on contractors tax arrangements. This guide aims to give an overview for the person setting out on the contracting path, who is thinking about using a limited company
What is contracting?
We need to have a clear idea of what we’re talking about here when we discuss contracting. What distinguishes a contractor from a freelancer or from a micro-business owner? Quite frankly there is no clear answer, and it comes down to the fine detail of your working arrangements, and even then there’s a lot of crossover. Traditionally what have become known as contractors are those people on long-term contracts probably working on behalf of one client at a time, who then move on to another client when that contract is over. Traditionally some IT experts or people in the film industry have worked this way. Over recent years these people have made use of limited companies as a tax efficient way to operate, and for all the legal protections inherent with a limited liability company. But we’ve seen a lot of debate around what is disguised employment, and HMRC certainly think that a good proportion of limited company contractors fall into the realms of being disguised employees, and therefore should be paying tax as though they were employed. They say that these contractors fall within tax legislation called IR35.
Not a contractor?
If on the other hand you are selling services or goods to multiple clients, then life can be much simpler, and you should consider the limited company or the self-employed route – please read our guide to Sole trader vs limited company. A plumber offering their services to the public would hardly think of themselves as a contractor, but they might be, if they worked for one engager – say a large leisure centre. You see where all this is going? It pays to know what your employment status is to ensure you are paying the right tax.
Your tax and employment status
Limited vs umbrella
This guide will provide an overview for those who fall into the realms of wanting, and being able to, offer their services through a limited company. However, some who may be ‘able’ to use a limited company, may end up, for convenience and risk reasons, using something known as an umbrella company. If you are deciding between these two options then do read our Limited vs Umbrella guide.
Generally speaking, Umbrella companies may be the preferred option of some engagers, and can be suitable for work with lower day rates and for short-term contracts – where it would be impractical setting up a limited company. An umbrella company is simply a limited company set up by an administration company, that your engager contracts with, and you provide your services through. Your status is an employee, and you are taxed as such. The umbrella company will have to pay employers national insurance, and they will charge you a fee.
You may well ask whether you have to set up a limited company at all. You can register as being self-employed. We’ve written a guide to help distinguish between these two trading structures. Many freelancers work as self-employed, otherwise known as sole-traders. A very general view of working this way is that it is probably more suitable to low income type work, and those where the trade doesn’t create a risk of running up debts or being sued, which is where the limited liability protection of a limited company is invaluable. A limited company, can be a more tax efficient structure to trade through vs self-employment our guide explains this in detail.
What’s your IR35 status?
Let’s get back to looking at working through a limited company.
If you do choose to go down this route it is vital that you ensure that your working arrangements don’t in fact constitute disguised employment.
Useful link: Contractors guide to IR35
We’d strongly recommend getting advice from a good tax specialist. There’s also plenty of good information on the HMRC website to help counterbalance all the professional advice and various articles on the topic.
As of the past couple of years, public sector employers have to take responsibility for determining your IR35 status. They will have to make up any unpaid taxes and NI if at a later date you are deemed within IR35. The government has just delayed doing the same thing in the private sector for larger engagers due to the Covid crisis – but are saying they will bring it in for the 21/22 tax year.
Still interested?
So you are comfortable that your way of working puts you outside IR35, and that you will be contracting long enough, or for enough money to make the cost and hassle of setting up a limited company worthwhile? Typically, a contractor accountant will cost around £1,000 per year, and an accounting software package like FreeAgent or Xero will cost you about £20 - 30 per month.
Can I work through a limited company and be in IR35?
The simple answer is yes, but you are limited to the amount of expenses (up to 5%) you can claim before tax and national insurance, and all the income from the contracts that fall under IR35 need to be withdrawn as salary, you can’t take it out as dividend. This means you’ll incur both employers and employees national insurance. This effectively wipes out any tax advantage, but you still keep the protections of a limited liability company.
Getting started as a limited company contractor
Your first step will be to register your Company with Companies House, which can be done online here https://www.gov.uk/limited-company-formation/register-your-company We’d recommend getting a reputable low cost contractor accountant to handle setting up your limited company.
Once you have registered with Companies House, you will receive your Companies House password and code. You then need your Government Gateway password and username allowing you access to HMRC's online services. Most returns made to HMRC will be made online. In order to complete your returns online you need to use your Government Gateway password to register with HMRC for individual returns, e.g. VAT. This should be done promptly to avoid any delays in making timely returns and incurring fines.
Annual returns & corporation tax
You need to make two different sets of annual returns to both Companies House and HMRC. These returns need to be made regardless of whether your company made a profit or not. If your business qualifies for the Small Business Exemption you may not have to get your accounts audited, which will save you money. Most small companies will qualify for this exemption.
Companies House require your Annual Return and your Annual Accounts. Failure to make them is a criminal offense. Your Annual Return is due 12 months and 28 days from the anniversary of the last Annual Return or the date of incorporation (for the first return). It gives details on your company such as shareholders, directors, etc.
Annual Company Accounts, different to the Annual Return, are required by law to be submitted to Companies House each year. They are due 9 months after the end of your company accounting period (ARD).
Failure to make your Annual Return and Annual Company Accounts on time can have negative effects on your company’s credit rating and result in your company being struck off. Companies House apply hefty fines for late returns so make sure to keep up to date. It is advisable to get help from an accountant in completing your annual returns and accounts, as they can be quite complicated, and mistakes could prove costly.
Corporation tax return
HMRC require your Corporation Tax Return (CT600) and your Company Accounts, both due 12 months from the end of your company's year-end. A late return will see a minimum fine of £100, which can rise dramatically as the fine will be a percentage of the tax owing and penalties for regularly late returns.
Paying corporation tax
Making your Corporation Tax Return and paying your Corporation Tax are two different activities. Your Corporation Tax payment is due 3 months before your return is due for the following year, ie. 9 months after your company's year-end. Late payment will earn penalties where interest is calculated on the amount owed.
Whatever earnings you do not take out as a basic wage or pay expenses will be deemed company profits and subject to Corporation Tax. The after-tax company profits can then be paid out to the contractor as dividends. Tax owing on dividends is collected through your personal Self-Assessment.
Taxes and Self-Assessment
Your company will have to corporation tax on any profits, and both employees and employers national insurance on any salary paid over the national insurance threshold of £9,500 (20/21).
Corporation tax rate 2020/21 – 19% (the Government was planning to reduce this, but decided to put it on hold at the last budget, a move that it likely to stay in place following the COVID-19 crisis.
Category A National insurance – employers and employees contributions 2020/21
| Category letter | £120 to £183 (£520 to £792 a month) |
£183.01 to £962 (£792.01 to £4,167 a month) |
Over £962 a week (£4,167 a month) |
|---|---|---|---|
| Employees | 0% | 12% | 2% |
| Employers | 0% | 13.8% | 13.8% |
[Source HMRC]
Running a limited company means you have the option to take your income out as salary or dividends or both. You can find a happy mix which keep your income tax and national insurance to a minimum. Note that dividends can only be paid from actual profits.
A lot of limited company contractors pay themselves up to the National Insurance threshold, and take the rest as dividends. This means they do not pay National Insurance but incur tax on the dividends which is lower than salary at the same levels.
Tax on Dividends 2020/21
| Band | Dividend tax rates |
|---|---|
| Basic rate (and non-taxpayers) | 7.5% |
| Higher rate | 32.5% |
| Additional rate | 38.1% |
| Additional rate | 42.5% |
| Current dividend allowance £2,000 (2020/21) | |
It should be noted that making no NI contributions at all can negatively affect your entitlements to a state pension and other state benefits. There is a way to get around this problem though. The Primary Threshold (PT) at which point you begin to pay NI is £183 per week, but once you earn over £120 a week, the Lower Earnings Limit (LEL), NI begins. If you keep your weekly salary between these two figures, technically (if not ethically) you will earn your NI credit without paying your contribution.
If you are under an umbrella company structure you will pay both employers and employees NI on the contract rate that the umbrella company is invoicing on your behalf. A limited company structure offers substantial NI savings to a contractor.
If you trade as a limited company you will be treated as an employee of that company for NI purposes and liable for Class 1 NI if you go over the primary threshold.
You will be required to fill in your tax self-assessment by January 31st for the previous tax year. For more on the topic of Salary v Dividends, see our Contractors Guide to Salary Dividends.
VAT - to register or not to register?
You will have to register for VAT if your billable income is over £85,000. If less than that you may wish to register to give the impression you are a high billing contractor – we know perception is all important in these things. You may also wish to take advantage of the flat rate scheme. The scheme basically allows you to pay an agreed % of the VAT you’ve collected. This amount depends on what line of business you are in, and the amount of costs you’ve incurred relative to turnover. This eliminates the need to claim VAT back on purchases. While on this scheme you generally do not claim back VAT on purchases, although you may be able to claim VAT back on capital assets worth more than £2,000 – which could be a powerful computer for a graphic designer. The percentage of VAT you pay differs depending on the type of business your company is. You will also receive a discount of 1% if it is your company's first year being VAT registered.
Useful link – HMRC flat rate explanation https://www.gov.uk/vat-flat-rate-scheme
This is one area where even HMRC suggest taking specialist advice, and we’d agree with them on that.
Another consideration with VAT is whether your clients can claim it back themselves; for example, financial services companies cannot. It may make you more competitively priced to such a firm, if you are not VAT registered.
Registering for VAT
Once you’ve received your Government Gateway password you can log onto HMRC online services and register for VAT.
Once registered, you need to make a VAT return each quarter, even if it is nil. If your return is late (you get a 7 day grace period if you file online), you will be in default. HMRC will then send you a 'Surcharge Liability Notice' explaining that there will be no fines as long as you send in your VAT return and are not late with any other VAT returns in the next 12 months. If you default again during this 12 month surcharge period, you may also have to pay a 'default surcharge' on top of your outstanding VAT. This is a percentage of your unpaid VAT at the due date.
Another reason to avoid late filing, and indeed making mistakes with your VAT filing, is it raises the chance of triggering a tax investigation. That is another reason to put your accounting in the hands of a good quality accountant.
Basic Tax saving tips for Contractors
Pay on time
The first and most effective tax saving tip is to make all your returns and payments on time. Late filing and payment penalties by both HMRC and Companies House are brutal and completely avoidable by making timely returns.
Know how much you owe
If you know your annual earnings are to go over the higher income earnings rate, put money aside throughout the year to pay your year-end tax bill. Opening a savings account and earning some interest off this tax owing can be a small extra benefit to being prepared for your tax bill.
Make full use of allowances
Making full use of all annual Personal Allowances, such as tax-free savings allowance, pension contributions, childcare vouchers, can sometimes mean the difference between passing into the higher rate tax bracket at the year-end or not. Also look at past years pension allowances - if they have not been used in full, you may be able to carry them forward and use them to reduce the gross income total for self-assessment purposes. For more, see our Guide to Using up you Allowances to Reduce your Tax Bill.
Claim your allowable expenses before tax
Contractors working under a limited company can claim many expenses as business expenses and pay for them out of gross earnings, using them to lower their tax bill. If you are not using the Flat Rate VAT Scheme, many of these expenses can be used to reduce the VAT bill also. Examples of allowable expense are computers, laptops, books, training courses, etc. Also, if you work from home, you can claim a certain portion of household bills as business expenses.
Useful link - HMRC working from home allowances https://www.gov.uk/tax-relief-for-employees/working-at-home
Get specialist advice
Get a reputable specialist contractor accountant on board. These specialise in dealing with limited company contractors and are well worth the fees they charge for their expert advice and services.
The tax year you receive monies determines which year it is taxed in
When are dividends "received"?
It is important to consider the “paid date” when declaring dividends close to the year-end. Interim dividends are deemed received by HMRC once they are paid to the shareholders. The date that interim dividends are paid can be altered by the company directors. This date is very important to the shareholders, as it determines which tax year the income is deemed to fall into.
For example, an interim dividend declared on 1 April 2020, paid on 4 April 2020, but not banked by the shareholder until 10 April 2020 is treated as income for the shareholder during the tax year 2019/2020 even though banked by the taxpayer after 5 April, the income tax year-end.
Final dividend is payable on a fixed date, proposed by the directors, confirmed by shareholders, which cannot be rescinded. The final dividend is deemed paid on the approved date, irrespective of when it is actually paid.
Pension Contributions
Pension contributions from your limited company are very tax efficient. Leave the money in your company as profit and you pay 19% corporation tax. Pay the money into your pension and you can pay in up to £40,000 (2020/21) without any corporation tax coming off first. Every penny goes into your pension.
Company pension contributions can be a useful tool in reducing end of year income tax liabilities, particularly if they bring earnings down into a lesser tax bracket. However, it is best to talk to an independent financial adviser before proceeding.
Conclusion
A limited company can be very tax efficient and provide low risk trading structure for a contractor who genuinely falls outside IR35. The wild west days of limited company contractors and accountants promising 90% of take-home pay is very much a thing of the past. But you shouldn’t be put off contracting in this way if you are inside IR35. The risk will hopefully move to the engager from 21/22 for the private sector contracts, as it is now with public sector contracts. So good luck.
Personal Tax
2019/2020 Tax Rates and Allowances
This page contains all of the personal income tax changes which were announced at the October 29th, 2018 Budget. These rates come into effect at the start of the new tax year, on April 6th 2019.
2018/2019 Tax Rates and Allowances
We have published a quick reference to the significant changes to the tax rates and bands, personal tax allowances and national insurance figures which come into effect from April 6th 2018.