What taxes I will pay when operating through a company?
One of the most confusing aspects of being a contractor is the myriad of different taxes your company has to pay. In reality, there are really only four areas you need to be concerned with and two of these will already be familiar to you as an employee and member of the public. Below, we have listed all four and given each one a brief explanation. One important note – when we say HMRC, this is the current term for what used to be called The Inland revenue.
- PAYE (or Pay As You Earn) – paid by your company
- VAT (or Value Added Tax) – paid by your company
- Corporation Tax – paid by your company
- Personal Tax – paid by you personally
This is the tax your Limited company pays over to HMRC for the tax and national insurance on a salary. If you have been an employee for any length of time, you will be familiar with the deductions seen on a monthly payslip. These are deducted from your salary and the employer pays them to HMRC. Exactly the same principle is applied to a company director. A salary is agreed between the Accountant and Director – resulting in tax and national insurance being paid to HMRC on that salary. The two important factors to be aware of are that tax of this kind is calculated using HMRC tax tables – and is directly related to the level of salary. Secondly, the company pays it “on behalf of” the Director. The recipient of the salary is not required to pay the tax and national insurance themselves.
It is a legal requirement for all business with an annual turnover of more than £70,000 to register for VAT. The current rate for VAT is 20% in the United Kingdom – a figure which puts us in line with most of Europe. Once registered, you will be required to add 20% onto all of your sales invoices. This extra 20% is then paid over to the VAT office once every quarter. You would be right in questioning the validity of VAT – especially as you receive it from your client and then pay it to HMRC. You also have to remember the client claims this VAT back from HMRC after being charged by you. In effect – the VAT money just goes around in a circle and is not really a tax at all.
In conclusion – the only people that really have to be concerned with VAT – are ourselves as consumers, as we cannot claim it back from HMRC.
Put very simply – this is likely to be the single largest tax your company will pay. It is payable 9 months and 1 day after your year end and is only paid once per annum. The current rate for corporation tax is 20% of your net taxable profit. We could fill a whole book on how this calculation is arrived at, but for the purposes of this guide the following formula will give you an indication.
Total net sales – expenses and costs (not dividends) = Net profitNet Profit x 19% = Corporation Tax.
Every year we complete a set of Financial statements for our clients and calculate their corporation tax liability. This is then filed with HMRC and they send you a bill for the corporation tax – it’s as easy as that.
Personal Tax (also known as your self assessment)
Whereas the first three taxes are all directly related to your Limited company, personal tax is actually related to you as an individual. Basically – it is a list of your personal income from 6th April in one year to 5th April of the next. You can think of it as a summing up of all your personal income and then a figure provided for what you owe HMRC personally. The return is filed once per annum. There are so many different aspects to a personal tax return, it would be impossible to list them all in this introduction. However, the typical self assessment return will include salary, dividends and personal bank interest received. Every company director needs to complete a personal tax return and your Accountant should do this for you. Important note – under no circumstances should you ever prepare and file your own return. If your Accountant allows you to do this, they cannot have taken your personal tax planning very seriously.
Just as a final footnote, let’s leave VAT aside for the moment. Part of the enjoyment of running your own Limited company is seeing how the other three taxes interact with each other. Logically – the higher your salary (it’s an expense) – the lower your corporation tax. One of the fundamental roles of your Accountant is to plan the three taxes for you and make sure they fit in with your lifestyle.