If you’re currently working as self-employed and have decided to set up a limited company, there are several differences in how each type of business structure is taxed. There’s no getting away from it, self employment tax and limited company tax are both complicated, but our guide will help you understand:
- Tax for the self-employed and limited company directors
- VAT
- Income tax for the self employed and limited company directors
- National Insurance Contributions
- Keeping business records
Tax for the self-employed and limited company directors
As a self-employed individual, your personal and business finances are treated as one for tax purposes, so your business profits are taxed via the annual self-assessment process, and you pay any income tax owed by 31st January each year.
If you set up a company, your personal finances and those of the company are completely separate entities. So, before any money can be allocated to shareholders or employees, the company itself must pay Corporation Tax on any profits made.
Currently, the Small Profits’ Corporation Tax rate is 19% (2020), assuming your turnover is £300,000 or less per year. This tax is payable 9 months and 1 day following the end of the period for which the corporation tax returns have been produced.
VAT
If your turnover has reached £85,000 (2020) or more during the year, you must register for Value Added Tax (VAT), whereby you must charge VAT on your products or services, and repay any taxes collected to HM Revenue and Customs, generally on a quarterly basis. You’ll need to register to collect VAT through whichever type of business structure you use – self-employed or limited company – if your turnover reaches the £85,000 mark. For more information, why not read out VAT Registration Guide here.
Most limited company contractors, with few business expenses, often register their company for the flat rate VAT scheme, an incentive introduced by the government to help simplify tax.
Income Tax
As we mentioned earlier, if you’re self-employed, you and your business are viewed as ‘one’ entity by HMRC when it comes to taxation. You pay income tax via the annual self-assessment process.
The limited company route is more tax efficient from a personal tax point of view, as you will typically take a small salary (with little tax liability) and the remainder of your income in the form of dividends (which are free from National Insurance).
Like self-employed individuals, all company directors have to complete a self-assessment tax return each year. This is when you pay any outstanding personal taxes you may owe on dividends and any other income you may have earned during the year. Don’t forget, your company is taxed separately from you, as a director. Visit our Contractor Tax page for more information on limited company tax.
National Insurance
Self-employed individuals and limited companies (and their employees) pay different types of National Insurance Contributions (NICs) altogether.
Self-employed workers pay Class 2 and Class 4 NICs, whereas limited companies and their employees pay Class 1 NICs.
If you’re self-employed, you must pay £3.05 per week (Class 2 NICs 2020/21), unless you have very low earnings. Class 4 NICs apply to your annual profits and are payable at self-assessment time. You’ll pay 9% on profits between £9,501 and £50,000 per year, and 2% on any profits made above this threshold.
For limited companies, both the company itself and its employees pay Class 1 NICs on salaries of more than £169 per week (2020/21). After this threshold, the company pays NICs of 13.8% on salaried income, and employees pay NICs at a rate of 12% on salaries up to £962 per week, and at 2% thereafter.
You should note that NICs are only payable on salaries, not dividends. This is the most important reason why the limited company route is more tax efficient than being self-employed.
Naturally, every contract is different, so we advise all SJD clients to speak to their dedicated accountant who understands the needs of limited company contractors, who can advise you on setting up a salary and payments through dividends. For for more information, read SJD’s guide to dividends.
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Accounting
Whichever business structure you use, you are obliged to keep accurate business records. You may not necessarily use an accountant if you are self-employed with a small number of transactions, however, almost all limited companies hire accountants.
Although limited companies have more complex accounting needs, a specialist accountant will look after all of your accounts and statutory obligations, so – despite what you may have heard – dealing with tax issues really isn’t a big deal. You will also pay significantly less tax than you would as a self-employed individual.
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