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Freelance Contractors and UK Dividends
If you decide to go into business with your own contractor limited company you could save large amounts of tax (specifically Class 1 National Insurance) on contract income generated outside IR35 by taking dividends.What is a UK Dividend?
A UK Dividend is a distribution of Limited Company profit to shareholders. Dividends do not attract national insurance contributions but are taxed where personal income is above the basic rate of tax of £36,000 per annum.Before a dividend can be paid to shareholders Corporation Tax must be applied to pre tax profits. The majority of freelance contractors running contractor limited companies pay corporation tax at the small companies rate’ of 20%. (Note: Corporation Tax is due to rise to 21% in 2009/2010).
Dividends are normally paid to shareholders by limited companies on a quarterly basis however as a freelance contractor you may wish to take dividends on a monthly basis to ease personal cash flow.
When a dividend is paid the correct paperwork must be generated. Where a payment takes place and neither company board minutes nor a dividend voucher are produced the dividend may be deemed invalid and considered income that should attract employed levels of tax by the HM Revenue and Customs.
Once paid to a shareholder there may be further personal tax to pay if dividends take annual personal income is above the basic rate of tax of £36,000. This is an important point to understand. Many freelance contractors that run limited companies think that once a dividend payment has been made to them by their limited company they have no further tax liability. If you expect to earn more than the basic rate of tax (£36,000) in the tax year you should put aside a rough tax provision of around 25% on income above the higher rate tax band to cover any higher rate tax liability as If you do not you may find it very difficult to pay at the end of the year. If the provision is overstated you will receive a final end of year payment.
Contracts Inside IR35
If you work on contracts Inside IR35 you cannot take income in the form of company dividends. Any contract income you receive through your limited company is subject to full income tax and class 1 national insurance deductions. This means you will be subject to large national insurance deductions, specifically employers national insurance which is 12.8% uncapped. Employees National Insurance is 8% but a 1% cap is in place at the higher rate tax limit.If you find that you more often than not you are taking contracts Inside IR35 it may be better to consider an umbrella company solution such as Expat Advantage or Payroll Umbrella. To discuss umbrella companies and contractor limited companies call Commonwealth Contractors now on 0800 294 4388.
Contracts outside IR35
If you work on contracts outside IR35 you can take dividends from the limited company and save worthwhile amounts of national Insurance. Freelance contractors outside IR35 normally take a low salary (which is subject to PAYE deductions including Income Tax and National Insurance), business expenses and the rest of the contract income in the form of company dividends.National Insurance is only payable on the salary. Therefore contractors taking dividends save 12.8% in employer’s national insurance and 11% + 1% in employee’s national insurance above salary income.
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