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.
This Guide was written by Patrick Gribben, contractor and freelancer Tax Expert at Intouch Accounting. Patrick now writes for Listentotaxman.com on matters relating to contractor and freelancer tax. He and his colleagues are very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the Intouch Accounting website for contact details.
Whether you’re new to contracting or you’ve been in the game a while, one thing every contractor will agree on is that they want to take home the maximum amount of pay they possibly can - that’s one of the reasons you made the choice to start contracting in the first place, right?
There are benefits to both business models and it’s important you understand the pros and cons of both to ensure you pick the one that’s right for you so you get the most out of it. So this simple guide will break it down for you, along with examples of what your potential earnings could be.
The Contractor's Choice; Limited Company vs Umbrella
As a contractor, how you choose to operate is entirely up to you. Your contracts can be routed through either your own Limited Company or through an organisation called an Umbrella Company which covers a number of contractors.
In most cases, medium to large organisations will only take you on as a contractor if you are operating as either a Limited Company or under an Umbrella Company. This is so that they don’t have to include you in the organisations payroll headcount. However, with the introduction of the new IR35 rules in the Private sector, if you are operating as a Limited Company you need to ensure you are clearly working outside of IR35 to avoid any trouble with the taxman. What does this mean? Check out our Contractor’s Guide to IR35.
Limited Companies
With a Limited Company, you are the director of your own private business. You have complete control over how you work and who you choose to work with. Most contractors work through their own Limited Company as this structure offers autonomy, limits individual liability and provides key tax benefits.
How you'll get paid
A Limited Company is the most tax-efficient way to operate. Contractors who work through their own company can save on tax and National Insurance contributions (NIC), compared to working as a permanent or Umbrella employee. However, the amount of tax and NIC saved depends on the level of income the company receives, and how the profits are paid out to you, the contractor. Getting expert advice from a contractor accountant will ensure you reap the tax benefits from the outset
As a Limited Company, you can pay yourself a basic salary and certain tax-free expenses, including a contribution to a registered pension scheme held in your name. Limited Companies must pay corporation tax, plus VAT and NIC on your salary (within limits). Any funds that remain represent profit which can be paid out as a dividend, or left within the Limited Company until you want to extract it or close down the company. The flexibility over when to take income out of the company offers further tax planning benefits.
You can choose how much to take as a salary, and therefore how much money will be left to pay out in the form of dividends. The mixture of salary and dividends affects how much tax you will pay, as dividends are currently taxed at lower rates than salaries (see below).
If you receive a salary of over £8632 per year you also have to pay employees and employers class 1 NIC. The tax rates due on the three bands of income are:
| Taxable income – after deduction of personal allowance | Salary taxed at | Employee’s class 1 NIC | Dividends taxed at |
|---|---|---|---|
| Basic – up to £50,000 | 20% | 12% | 7.5% |
| Higher – £50,001 to £150,000 | 40% | 2% | 32.5% |
| Additional over £150,000 | 45% | 2% | 38.1% |
|
Notes
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Advantages
- A Limited Company offers the most tax-efficient solution in terms of retaining as much of your earnings as possible.
- You keep complete control of all company matters, allowing for greater opportunities for tax planning. This includes drawing dividends, claiming expenses and making pension contributions
- You have full ownership of your revenue as your client pays directly into the company bank account rather than passing via an Umbrella Company – this means faster transaction times and no risks to your earnings
- Greater flexibility and independence as you retain control over which contracts you secure and can work as much or as little as you choose.
- There is limited personal liability as company assets are separate from personal assets.
Disadvantages
- As a Limited Company director, you'll have a number of statutory and financial obligations to HMRC and Companies House; you will be responsible for your company's financial accounts, submissions and meeting your HMRC tax deadlines.
- You'll also be responsible for the day to day management of your company, including invoicing, record keeping and financial management.
- There are heavy penalties if tax returns are not filed when due, payments are not made on time or reporting mistakes are made.
- You are at higher risk of being caught by the IR35 legislation - you must ensure you are working as an entirely separate entity to any organisation you are contracting for, and be able to provide proof of this. If you are found to be operating within IR35 and not declaring it, you could be taxed more and fined.
It's worth noting that most of the administration and paperwork that arises from owning a Limited Company can easily be taken on by a specialist contractor accountant, and this will greatly decrease the risk of any penalties.Your accountant will also be able to give you guidance and advice on your IR35 status for any current or new contracts, advise you on whether trading as a Limited Company is right for you and set up your company in the most tax-efficient way.
Conclusion
Operating as a Limited Company is the most common choice for contractors and when done strategically, can be the most financially beneficial by combining salary and dividends to ultimately pay less tax.
If you opt to set up as a Limited Company, it is highly recommended that you seek the advice and support of a specialist contractor accountant who can take care of all the paperwork and administration for you. They will also be able to give you advice on how you can maximise your take home pay and answer any queries you may have about your IR35 status.
Umbrella Companies
When you join an Umbrella Company, you effectively become an employee of that corporation. While it's not as tax efficient as using your own Limited Company, Umbrellas offer a relatively stress-free way to contract. This can appeal to first time or short-term contractors or those who'd rather not take on any form of administration. Operating under an Umbrella Company also makes determining your IR35 status a lot easier, and there is no problem working within IR35 in this situation as long as you’re aware that your tax and NIC will be calculated at the standard rate, rather than based on how much you earn.
How you'll get paid
- 1. When you are placed on a contract, you submit the hours worked and your expenses each week to the Umbrella Company; this is usually through an online system.
- 2. The Umbrella Company invoices the recruiter or the client directly.
- 3. You are paid (via PAYE) a salary, after deductions for tax, National Insurance, expenses, the Umbrella fee, and any other pre-agreed costs, by the Umbrella Company and receive a payslip.
- 4. The Umbrella Company supplies you with a P60 and a P11D each year as you are an employee of the Umbrella.
Advantages
- There's significantly less initial outlay in terms of time or expense compared to setting up your own Limited Company. There's no company set-up, you simply sign up (enter an employment contract) and you're ready to start contracting.
- You are not the company director and have no responsibility for the financial accounts and tax returns of the Umbrella Company.
- As an employee of the Umbrella, they'll collect your money on your behalf from the client and pay you a salary after deducting their fees and any tax due.
- Umbrella Companies hold the contract with the recruitment agency or client and therefore handle all the contractual side of the relationship for you.
- There’s less likely to be discrepancies about your IR35 status as you are clearly paying the necessary tax and NIC through PAYE.
Disadvantages
- You are not a director of the Umbrella Company, you have no control over the company nor the company's accounts and policies.
- You take on a certain amount of risk as your money travels through the bank account of a company you have no control over. Should the Umbrella Company fail or the directors of that company be prosecuted for any reason, you could lose any money being held by them at the time.
- Agency worker regulations mean that if your contract lasts for 12 weeks or more you must be granted the same employment rights as permanent members of staff. This includes being paid holiday pay, sick pay, and pension contributions. The Umbrella Company administrator may withhold a proportion of your salary to cover these costs.
- You still remain responsible for your own tax affairs including submitting a self-assessment tax return, if HMRC ask you to complete one.
- You are responsible for finding a compliant Umbrella Company; some companies offer above-average rates of return and these could later be considered tax avoidance schemes by HMRC; as a contractor you will still be liable for any tax unpaid and any penalties.
Conclusion
Umbrella Companies offer an alternative to managing your own business. Umbrellas take care of the majority of the administration, leaving you to get on with contracting. The arrangement can be attractive to new or short-term contractors as it requires less of a commitment than having your own Limited Company. You can join an Umbrella and can leave relatively quickly, whereas setting up a Limited Company attracts more responsibility through your duties as a director of the company. Umbrellas however, are significantly less tax-efficient than running through your own Limited Company.
Number crunching
Comparing the potential take home pay between a Limited Company and an Umbrella is complicated. It's dependent on a multitude of individual factors such as your work practices, expenses and the costs of an accountant or the fees associated with an Umbrella. Here, we've chosen standard values and set out two examples to compare the tax benefits at two levels of income. As you can see, the financial gain from operating under a Limited Company structure is slightly more than the Umbrella structure at £30,000. The tax advantages of the Limited Company are far greater at the £60,000 level of annual income.
Annual Income £30,000 | ||
|---|---|---|
| LimitedUmbrella | ||
| Annual Income | £30,000 | £30,000 |
| Add Flat Rate VAT Saving | £60 | £0 |
| Turnover | £30,060 | £30,000 |
| Expenses | £2,400 | £0 |
| Accountancy Fees | £1,512 | £780 |
| Salary | £8,632 | £26,723 |
| Employers NIC | £0 | £2,497 |
| Pre-Tax Profit | £17,516 | £0 |
| Corporation Tax | £3,328 | £0 |
| Profit After Tax | £14,188 | £0 |
| Personal Income Details | ||
| Gross Salary | £8,632 | £26,723 |
| Less - PAYE on Salary | £0 | £2,843 |
| Less - NIC on Salary | £0 | £2,171 |
| Net Dividends | £14,188 | £0 |
| Less - Tax on Dividends | £624 | £0 |
| Expenses | £2,400 | £0 |
| Total Income After All Taxes | £24,596 | £21,709 |
| Take Home Pay % | 74% | 72% |
| Annual Income £60,000 | ||
|---|---|---|
| Limited | Umbrella | |
| Annual Income | £60,000 | £60,000 |
| Add Flat Rate VAT Saving | £120 | £0 |
| Turnover | £60,120 | £60,000 |
| Expenses | £2,400 |
|
| Accountancy Fees | £1,512 | £780 |
| Salary | £8,632 | £53,085 |
| Employers NIC | £0 | £6,135 |
| Pre-Tax Profit | £47,576 | £0 |
| Corporation Tax | £9,039 | £0 |
| Profit After Tax | £38,537 | £0 |
|
|
||
| Personal Income Details | ||
| Gross Salary | £8,632 | £53,085 |
| Less - PAYE on Salary | £0 | £8,730 |
| Less - NIC on Salary | £0 | £5,026 |
| Net Dividends | £38,537 | £0 |
| Less - Tax on Dividends | £2,450 | £0 |
| Expenses | £2,400 | £0 |
| Total Income After All Taxes | £47,119 | £39,329 |
|
|
||
| Take Home Pay % | 75% | 66% |
A note on IR35:
Your IR35 status (which can vary from contract to contract) determines your tax position with HMRC. IR35 runs across every business sector and specialism and the financial impact is significant depending on where you stand.
If you operate inside IR35, then you will be taxed as though you’re an employee, subject to PAYE and National Insurance; which is where operating under an Umbrella Company could be safer if you feel your contracts will often fall within IR35. However, this does mean your take home pay will likely be less than if you were operating as a Limited Company.
If you're working through a Limited Company and are genuinely operating outside of IR35, you can take advantage of the personal allowance and use a dividends model to pay yourself, ultimately maximising your take home pay.
If your contracts are predominantly outside of IR35, a Limited Company remains more tax-efficient than an Umbrella. As well as letting you take home more of your earnings, a Limited Company allows you to flexibly accept contracts both outside or inside IR35. Whereas an Umbrella Company would leave you out of pocket for any future work you undertake that’s outside of IR35. But working through an Umbrella would mean that you never need to worry about being caught by IR35.
If you’re not sure where you stand with the IR35 legislation, then have a read of our Contractor’s Guide to IR35
To help you determine what your status is. You can also find out about any updates or changes to rules to ensure you are following this legislation correctly.
Next steps
Still unsure which option would be best for you? We would strongly recommend seeking professional advice to help you make the right decision on whether a Limited or Umbrella Company is better suited to your circumstances and requirements. A specialist contractor accountant will also be able to give you professional IR35 advice to ensure you always stay on the right side of the tax man.
This Guide was written by Patrick Gribben, Tax Expert for contractors and freelancers at Intouch Accounting. Patrick now writes for Listentotaxman.com on matters relating to contractor and freelancer tax. He and his colleagues are very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the Intouch Accounting website for contact details.
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.