TAX PLANNING FOR LIMITED COMPANY FREELANCERS AND CONTRACTORS

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1 TAX PLANNING FOR LIMITED COMPANY FREELANCERS AND CONTRACTORS 2016/17 E-Book by JF Financial Management Limited

2 Contents Disclaimer... 3 Introduction... 4 Limited companies - an introduction... 5 Corporation tax... 6 IR35 employment status... 7 Personal service / substitution... 8 Mutuality of obligation... 8 Control... 9 Other important factors... 9 Summary... 9 Salary vs dividends Dividends and tax Optimal levels of salary and dividends for Leaving profits in the business Student loan repayments Child benefit k+ earnings Multiple shareholders Dividends paperwork etc Salaries paperwork etc Splitting income with your spouse Making your spouse a shareholder Is income splitting risky? What if you re not married? Paying your spouse a salary Alphabet shares Allowable business expenses Out of pocket expenses vs company incurred expenses Benefits in kind Mobile phone Broadband / internet Travel Subsistence JF Financial Management Limited Page 1

3 Business entertaining vs subsistence Staff entertaining Accommodation expenses Holidays and overseas travel Accounting fees Software Computer and office equipment Bicycles Working from home Subscriptions and publications Subcontractors Training costs Clothing / work wear Medical expenses Charitable donations Childcare vouchers Benefits in kind Company cars Vans Pension contributions Personal vs company pension contributions Company pension contributions Summary Workplace pensions / auto enrolment Director loan accounts VAT registration Compulsory VAT registration Voluntary VAT registration What is the standard VAT scheme? What is the flat rate scheme? Other issues Tax data 2016/ JF Financial Management Limited Page 2

4 Corporation tax A company pays corporation tax on its taxable profits. The corporation tax rate for 16/17 is 20%. Corporation tax is usually due for payment to HMRC within 9 months and 1 day of the end of the company s accounting year (lets just say 9 months for simplicity). For example if a company s accounting year end is 30 th November 2015, the corporation tax should be paid to HMRC by 31 st August The accounts should also be filed by this date. For most contractors and freelancers, taxable profit is usually calculated by taking the company s turnover (its sales excluding VAT), then taking off allowable business expenses that will also include salaries (but not dividends). There are often some adjustments that need to be made by the accountant for things like depreciation and client entertaining which are not allowable for tax, but to keep things straight forward see an example below of a simple corporation tax calculation: Turnover excluding VAT 75,000 Less business costs: Travel (3,000) Subsistence (750) Computer equipment (800) Office equipment (300) Software (300) Salaries (8,040) Profit before tax 61,810 Corporation tax (20%) (12,362) Profit after tax 49,448 JF Financial Management Limited Page 6

5 Leaving profits in the business Something to consider is that one of the great benefits of trading through a limited company is that you have more control over the timings of when you are taxed. Yes, your business is always going to pay corporation tax on its profits in the year the profits are earned, but you can choose when you take dividends out of your business so you have some control over your personal tax position. Even if your company has plenty of profits, you may choose to not extract more than the 43k of your salary and dividends to minimise your personal tax bill and just let any additional profits remain in the business until further down the line. You may have a use for these additional profits such as making company pension contributions (see section on this topic later in the book) or perhaps you want to invest in some particular equipment in the future. Other tax considerations Although our advice above covers personal income tax, there are a few other topics to consider: Student loan repayments If you have a student loan balance, then you may have some repayments to make through your personal tax return (self assessment). There are now two different types of student loans: Plan 1 and Plan 2 If you lived in Scotland or Northern Ireland when you started your course, or you lived in England or Wales and started your course before 1 September 2012 then you have Plan 1. If you lived in England and Wales and started your course on or after 1 September 2012 then you have Plan 2. You pay back 9% of your income over the thresholds of: 17,495 for Plan 1 21,000 for Plan 2 Dividends from your company as well as your salary will count as earnings for student loan repayments so if you are taking salary and dividends from your company that take you over the student loan thresholds then you will have some student loan repayment to make through your personal tax return. For example if you are on Plan 1 and you have salary and dividends totalling 43,000, this will mean 2,295 of repayments for 16/17. JF Financial Management Limited Page 15

6 Dividends paperwork etc. In this section we cover the practicalities around paying dividends. As per the Companies Act, your company must have sufficient post tax profits to cover a dividend. The post tax profits are looked at on a cumulative life-to-date running basis, not just the specific period you are looking at. So you should look at your company s post tax profits life-to-date, less any dividends that have been paid out in the history of the company. This figure then tells you the distributable profit of the company. If you have been running your company for several years you can get the previous years retained profit at the end of the year from your accounts, and then just adjust for the current year position. We recommend an online book-keeping system called FreeAgent which makes it simple to assess your profits available for dividends. When it comes to paying the dividend, it should be paid in proportion to the shareholdings. So for example if your company is owned 80% by you and 20% by your spouse, and you decide to pay a 5,000 dividend, two payments should be made, one to your spouse for 1,000 (ideally to their personal bank account) and 4,000 to you. This assumes there is just one class of ordinary shares, which is usually the default situation (we discuss Alphabet shares later on). Generally it is advisable to not extract all of the available profits when you pay a dividend, it is good practice to keep back some buffer in case future months are not as profitable as you are expecting. For contractors and freelancers building up a buffer can be useful to help smooth any gaps between contracts / freelance work, as you can still keep drawing dividends as long as there are sufficient profits. Please be aware that if you pay dividends out of losses these are illegal per company law and can cause serious tax issues with HMRC. You need to also draw up some paperwork when you pay a dividend. This should be a simple board minute confirming the details of a meeting at which the dividend was voted. It should confirm the total dividend payable and how much is paid to each shareholder. Ideally you should draw up this paperwork at the time of the meeting, print it off, sign it and file away. JF Financial Management Limited Page 17

7 Travel HMRC have brought in new rules for 16/17 for travel and subsistence. They have said that if you are under the supervision, direction or control (SDC) of a client then you cannot claim travel and subsistence. In reality this will only apply if you are caught by IR35 (see earlier section in book). Assuming you are not caught by IR35, read on. Understanding what travel expenses can be claimed from your limited company can be a little tricky - the key is that there is a difference between a temporary workplace and a permanent workplace. Travel to a permanent workplace cannot be claimed as this is seen by HMRC to be ordinary commuting, whereas travel to a temporary workplace can be claimed. What is a temporary workplace? There are two key concepts to understand here - the 24 month rule and the 40% rule. The 24 month rule As long as you are not working in a location for 24 months or longer the location will be considered to be a temporary workplace, therefore travel can be claimed. However, if you sign a contract that means you know you will be in the same location for more than 24 months then you cannot claim travel from that point. It is the point at which you know you will be there 24 months or longer at which the location changes from being a temporary workplace to a permanent one. If for example you sign a contract now for 12 months and then 10 months into the contract you sign an extension for 18 months, then the location would change to being a permanent workplace 10 months in so you could only claim the first 10 months travel. The 40% rule Even if you do breach the 24 month test, there is still a chance to claim some of your travel costs if the location represents less than 40% of your overall business working time. Below 40% and it will still be considered a temporary workplace. You need to assess the previous 24 months on a rolling 24 month basis all the time to see if the 40% rule has been breached at any point. Once it is breached you have to stop claiming your travel, however keep your eye on the rolling 24 months position each month as you may dip under the 40% again, at which point you can start claiming your travel again. What about if you work on contracts in similar areas? This is where things get a bit more complicated. If you work with Client A in Location A for 15 months and then move to a new contract with Client B in Location B for 12 months, location A and B must be in different locations otherwise they could seen to be in the same 'patch' by HMRC. If workplaces are in similar locations and there is not much difference to the travel route then HMRC could argue they are one permanent workplace. JF Financial Management Limited Page 26

8 Business entertaining vs subsistence The above subsistence costs refer to a situation where an employee or director is simply claiming their own food and drink costs in relation to allowable business travel. If costs are incurred when entertaining business contacts or clients these are referred to as business / client entertaining. As long as they are for genuine business purposes they can usually still be claimed but they are treated as disallowable for corporation tax purposes. Although business entertaining is not an allowable expense for corporation tax it is still a real cost for the company so it is beneficial to claim this back from your company for example if you have paid 50 out of your own pocket on entertaining a client, it is usually better to claim this back from your company than to have to extract a further 50 in dividends to cover it. As with any business costs they must be wholly and exclusively incurred for the purposes of your business. HMRC may challenge a cost if it considers that the primary motive for incurring it is to obtain a private benefit for a director or employee. In order to claim Business Entertaining make sure you keep the receipts and note the below: - Who were you entertaining? - For what business purpose? - Where was it? - When did it take place? Staff entertaining As a limited company freelancer or contractor you will not usually have any staff other than yourself and perhaps your spouse, but you are still a staff member and are entitled to a certain level of staff entertaining expenses. An annual staff party is allowable as a business expense as long as the total cost is not more than 150 per staff member inclusive of VAT and other related costs such as travel and accommodation. So if you are a husband and wife company that s 300 in total. It can either be a single annual party such as at Christmas or could be split into smaller events. The events should be ones that recur each year though. In practice for a limited company freelancer or contractor a once or twice a year social is ok, just make sure you don t exceed the 150 per year each. If you go over the 150 limit then the whole cost becomes taxable not just the additional amount. All staff have to be invited but this is not likely to be relevant for a contractor or freelancer. Please note that sub-contractors count as clients, not staff, for entertaining purposes, so don t invite anyone else! JF Financial Management Limited Page 30

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