There is no getting away from it – tax in the UK is complicated. However, this guide aims to break down the deductions you can expect to see from your pay as a contractor and hopefully give you a fuller understanding of what’s going on with your money.
First, we will break down how tax works through an Umbrella Company – often the first destination for a contractor and certainly the easiest. Next, we will touch on how tax is handled through a Limited Company. Being paid through a Limited Company tends to be the most tax efficient way to be paid, although this depends on your personal circumstances – see our Umbrella vs. Limited guide to see which is best for you.
Tax through a Limited Company
This is a little more complicated, since your Limited Company will pay you both a salary – as an employee – and dividends – as a shareholder. It is also required to pay Corporation Tax on its profits. Managing the different thresholds and tax rates for optimum tax efficiency is one of the main reasons you pay a specialist contractor accountant, like Dolan Accountancy!
Salary is calculated as above. It is extremely common to be paid a salary which falls below the 0% income tax threshold, with minimal or no National Insurance being due.
Corporation Tax is paid at 19%-25% on all profits a company makes. Profits are the income of a company, minus salary paid and any expenses incurred in running the business (for more information on tax-exempt business expenses, see our contractor expenses guide).
VAT is charged on all invoices you issue for services and goods provided. This is a fixed rate of 20%. Contractors are usually registered on the Flat Rate VAT Scheme, which means that you charge VAT at 20% on your net invoices, but only repay it at 16.5% on your gross invoices. The difference is counted as profit for the purposes of Corporation Tax, but usually still adds up to a net saving.
Dividend Tax is payable personally on profits paid to you as dividends, from your Limited Company. There is a £500 tax free threshold for dividends, no matter your total income. Dividends that fall into the lower rate are taxed at 8.75%; 33.75% for dividends in the higher rate and 39.35% for dividends in the additional rate.
The different forms of taxation related to a Limited Company can be complicated and interact with each other in different ways. Don’t be afraid of the different terminology! Drawing money from a Limited Company in the most tax-efficient manner is the bread and butter for any good contractor accountant.
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Tax through an Umbrella Company
Umbrella taxes are handled through PAYE – the UK’s pay-as-you-earn income tax system, used for permanent and salaried employees. There are also National Insurances to be paid. All figures are correct as of 2024-25.
Employer’s National Insurance: Before an employee can be paid, the employer – in this case the Umbrella Company – has to pay Employer’s NI. As of 2024-25 this is 13.8% of all income above £175.01 a week.
Employee’s National Insurance: Once money is paid to you, you pay 8% of all income between £242.01 to £967 per week and then 2% of income over £967 per week, as National Insurance. This means that up to 21.8% of all income earned will be paid to HMRC for National Insurances.
Income Tax: Income Tax is based on annual thresholds. No tax is applied to income below £12,570. 20% tax is applied to the next £37,700 of income and 40% tax is applied to income above this. If you earn more than £125,140, 45% tax is applied.
As an employer, the Umbrella Company is also liable for additional taxes such as the Apprenticeship Levy, which all businesses must pay when making payment to an employee.
For a personalised illustration of your take-home pay, making best use of your various tax allowances and thresholds, give one of our specialist contractor accountants a call on 01442 795 100 or email sophie.lewis@dolanaccountancy.com.
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