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Contractors and freelancers – paying yourself via a limited company

October 11, 2011

If you are contracting or freelancing via your own limited company, how you draw down income from your company will depend on several factors, the main one being your IR35 status.

The IR35 tax legislation applies to work you do which is deemed to be akin to ’employment’ as per HMRC’s employment status guidelines.

The rules apply to the actual conditions of the contract (both written and in practice) rather that the contractor, so some of your work may be caught and some may not.

Outside IR35

Clearly, it is in the best interests of contractors to ensure that their work falls outside the IR35 rules.

The most tax efficient way of drawing income from your company is via a small salary (possibly devoid of any income tax or NICs), and the rest in the form of dividends.

Limited company dividends can be declared out of post-tax profits, and are subject to dividend tax of 10%, 32.5% and 42.5%, depending on the tax band your income falls within. NICs are not payable of dividends, which is one of the main attractions of incorporating.

You can find out more in our article – how are dividends taxed?

Inside IR35

If your work falls within the IR35 net, all of your income aside from a 5% expenses ‘allowance’ must be taken as your ‘deemed salary’, subject to the standard PAYE and NIC rules.

This allowance, which represents 5% of your turnover on relevant engagements, covers the administrative costs of running a company. You can also claim for travel, accommodation, pension and a few other items on top of this administrative allowance.

Even if you are caught by IR35, there are still benefits to be had from using a limited company rather than another business structure, but they are massively reduced.

For this reason, we strongly recommend you seek advice from an employment status expert before undertaking contract work. You may also consider taking out tax protection insurance which will cover the costs of representation in case your status is challenged by HMRC.