From invoice to payslip. Getting paid is simpler than you think.
Learn everything you need to know about getting paid as a contractor or consultant.
Choosing the right structure for you
An introduction to tax
“Choosing the right structure?” You’d be right to ask why you need to bother at all. It’s a straightforward answer: it’s all down to tax, and specifically, making sure you’re paying the right amount.
As an employee, you rarely have to worry about the mechanics of taxes. You turn up for work, your employer pays you, they take care of paying the taxes to HMRC, and you take home your salary.
Behind the scenes, your employer is taking care of paying your taxes. They pay your income tax and National Insurance contributions to HMRC. They also pay their taxes to HMRC (employer’s National Insurance and the apprenticeship levy). And they’ll also make payments into your pension – both your contribution and theirs.
When you start contracting or consulting, when your invoices are paid they are normally untaxed. You can’t just take the money and be done. You need to go through a similar process to an employer, and make sure you’re deducting and paying the right amount of tax before you pay yourself.
That’s why you need an umbrella company or a limited company: it’s a way to take your untaxed income, pay the taxes to HMRC, and then pay yourself.
An introduction to umbrella companies
There are two main ways to handle this untaxed income, by either using a third-party umbrella company or by using your own limited company.
Umbrella companies are simply payroll companies. If you use an umbrella, you’ll become an employee on the payroll of the umbrella company, alongside other contractors and consultants. When your client pays your invoice, they pay into the umbrella company’s bank account. The umbrella company then takes this payment, calculates, deducts and pays to HMRC all the taxes due, then pays the balance to you. They’ll pay it directly into your personal bank account, and you’ll get a payslip. Your tax is taken care of.
There’s a small point to keep in mind. Your client will pay you a gross rate, from which you’ve got to not only pay your employee taxes, but you also need to pay the employer taxes from this. You’re picking up the bill as both employee and employer – and it all needs to come from your contract rate.
If you were a regular employee with a gross salary of £80,000 you’d take home around £55,000 after tax. If you had an £80,000 contract via an umbrella company, you’d take home around £49,000 – you’d be £6,000 worse off. That’s why it’s so important to negotiate a higher rate, because your tax burden will be higher.
An umbrella is very easy to set up, and very easy to use. The main downside of an umbrella is the cost and lack of flexibility. All of your income passes straight through the umbrella, and is paid to you as a salary. Whilst it is straightforward, it does mean you’re missing out on flexibility and the ability to optimise your taxes.
An introduction to limited companies
Another option is to get paid via a limited company. This is a company that you own, and it has its own business bank account. Your client pays your invoice into your company’s bank account. At this point, the money is owned by your company, and you now have the flexibility to decide what you want to do with it. And the amount of tax you’ll pay varies depending on what you do with your income.
For example, you could:
- Hold the money inside your company for a rainy day, or to take 3 months off each winter
- Invest in training courses, certifications, computer equipment & licences to keep your skills current, and to drive up your daily rate
- Invest in building an app, some content or a training course to sell or license to others
- Invest in a company pension
- Buy an office, or invest in residential rental property
- Pay yourself a salary, or pay others a salary to help you run your business
- Pay yourself a bonus as a dividend payment, and share this with your spouse/partner
Each of these options is treated differently when it comes to tax, meaning your taxes will be optimised around your personal situation and goals. Contrast this to an umbrella – an umbrella treats all of your income as pay and taxes as such. It’s this flexibility that makes limited companies so popular.
Download our free book “Preparing to set up your limited company”. You’ll learn how to choose a name, appoint directors and shareholders, protect your personal privacy, choose an accountant, open a business bank account, and much more.Download now
What about self-employment?
There’s also a third option: self-employment, also known as being a sole trader. When you’re self-employed, you keep track of your income and outgoings and then pay taxes on your profit every year via a Self Assessment tax return. There’s no need to set up a company – you simply need to tell HMRC you’re becoming self-employed.
These days, self-employment is becoming a hinterland. It’s more hassle than an umbrella, but with only a few additional advantages. Legislation change has made limited companies far easier to set up and run, offering you greater flexibility than being self-employed with very little extra effort.
As well as flexibility, there is another significant advantage of a limited company over self-employment: you can minimise your risk should something go wrong. If you’re self-employed, you are personally liable for any problems or debts that arise from running your company. There is no separation of your business affairs and your personal affairs.
Limited liability companies – to give limited companies their full name – offer you much greater personal protection. A limited company is a stand-alone business, which is separate from your personal affairs. This means, should something go wrong, the buck normally stops with the company. If, for example, you deliver poor advice or faulty software, your client can sue your limited company but your personal assets (for example, your home) are protected. This is not the case if you’re self-employed.
Therefore, for most people considering self-employment, setting up a limited company is a far more appealing option.
Are you a ‘disguised employee’?
It all sounds idyllic so far. You can form a limited company, take control of your earnings and optimise your tax position. If it’s so easy and advantageous, it makes you question why anyone bothers being an employee?
The government is very keen to make sure that employees are taxed as employees, and business owners are taxed as business owners. That’s why we have IR35 legislation. IR35 says that if you’re acting like an employee (a ‘disguised employee’), you should be taxed as an employee. This means that if the IR35 legislation applies to your role, you’ll pay income tax and National Insurance on everything you earn, and you’ll forgo the flexibility of managing your income.
Your IR35 status isn’t about you, your job title, or your skills. It’s about the relationship you have with your client and how they choose to work with you. HMRC estimates that overall, two-thirds of contracts are not subject to IR35, and a third are. In our experience, we often see that lower paid, or more junior roles which require greater supervision are subject to IR35. Our clients who are more experienced and work on a consulting basis, with very little supervision, generally find themselves free of IR35. If you’re planning on working via a recruitment agent, do talk to them – they should be able to tell you if the position is subject to IR35 or not.
Summary: when should I use an umbrella company?
Using an umbrella company is right for you if:
- You just want to take home a salary and have limited financial goals beyond this
- You’re going to try contracting or consulting as you’re not sure if it’s right for you
- Most of your work will be subject to IR35 – e.g. you’ll be a ‘disguised’ employee
- You favour simplicity above everything else
- You can’t trust yourself to pay your taxes / to not spend all of your income
Summary: when should I use a limited company?
Using a limited company is right for you if:
- You think you’ll be contracting or consulting for at least a year or two
- You’d like to optimise your earnings and taxes around your personal financial goals
- You’re planning on earning over £30k
- Most of your work won’t be subject to IR35
- You’d like to separate your personal and business affairs
- You’re delivering high value/impact services where you could be held to account for quality, and want to protect yourself from risk
- You’re thinking about employing others, outsourcing work, or using an ‘associate’ model
- You’d like to employ your partner to help with your administration work
- You’d like to make your partner a shareholder to share dividends with
- You need to invest in training, certification or computer software/hardware to deliver your services
- You’re aiming to build something of value to license or sell
Getting paid via an umbrella company
Invoicing your clients
Umbrella companies often work closely with recruitment agents. You’ll send a timesheet to your umbrella company, and they’ll then pass this on to the recruitment agent for approval and payment. The recruitment agent will normally produce an invoice for you (“self-billing”) and send this back to the umbrella, along with payment. The umbrella company now hold your gross payment from your client.
Claiming expenses and mileage
You cannot claim expenses or mileage via an umbrella company unless your client has agreed to pay them. You cannot, for example, purchase a mobile phone, laptop or invest in training.
Calculating your taxes
The umbrella company will then perform a clever calculation to determine how much employment taxes are due – that’s employers National Insurance and the apprenticeship levy. This will often appear on your pay statement as a “service charge”, alongside the fee for the umbrella itself.
They will then calculate the tax due on the remaining amount as if it were your salary, so they’ll calculate employees National Insurance, income tax, pension payments and student loan repayments.
Paying your taxes
Each month your umbrella company will transfer your money to HMRC to pay your taxes – both employers and employees.
Getting a payslip
You’ll be given a payslip showing your income and deductions. The umbrella company will automatically transfer the net amount into your personal bank account. This is now yours to spend.
Getting paid via a limited company
Invoicing your client
If you use an agent, you’ll normally send them your timesheet and they will produce an invoice for you. If you’re working directly with a client, you’ll need to produce an invoice so they know how much to pay you. The agent or client will then pay the invoice balance directly into your company’s bank account.
Claiming expenses and mileage
Unless you’re subject to IR35 (see above), you can claim expenses and mileage. Typical day to day expenses include travel to and from your client’s office (including 45p per mile driven in your own car), subsistence (lunches etc), and accommodation costs if you’re away from home overnight. You’ll simply repay the amount you owe yourself from your company’s bank account, and your expenses will reduce your overall tax bill.
Paying yourself (and others) a salary
Next, you’ll likely pay yourself a salary. This salary will be subject to the same employers and employee taxes as if you were a regular employee. You have the freedom to determine how much you’d like to take as a salary. In general, the more you draw as a salary, the less tax efficient you are. Some people like to set a salary at a level that covers their household outgoings, and no more. Others like to draw £12,500 – this is your personal allowance, the amount you can earn before paying income tax.
You’ll pay yourself the net salary directly from your company’s bank account, and you’ll pay the taxes to HMRC every quarter.
Paying into a pension
If you’re saving for retirement, you can pay directly into a company pension scheme. You can invest up to £40,000 tax free per year into a pension and for every £100 that you pay into a pension scheme, it effectively only costs your company £81, because it reduces your corporation tax bill. This is undoubtedly the most tax efficient way to withdraw profit from your company.
Paying corporation tax
You now need to pay corporation tax on the money that’s left over. Your accountant will calculate this for you, and tell you when you need to pay it – again, it’s a simple payment to HMRC from your company’s bank account. As it can be so long between payments, you’ll need to remember to set the money to one side – we’ll shortly show you how inniAccounts makes this straightforward.
Saving for a rainy day
The money that’s left over is your profit, after tax. You now have two main choices: save it, or withdraw it.
You can keep it inside your company – perhaps you have a savings or investment goal, or if you’re planning on working, for example, 9 months on, 3 months off, retaining profit inside your company is helpful to smooth your income. In this case, there’s nothing left to do. Just keep the profit in your company’s bank account.
Paying yourself (and others) a dividend
If, on the other hand, you’d like to withdraw it, you can take it out as a dividend. This is a payment that you receive as a shareholder in the company. You can take a dividend whenever you like, you just need to make sure you have enough profit left to cover it!
When you withdraw a dividend, you’ll need to pay personal income tax on the dividends. You can draw £2,000 per year tax-free, and after that, the amount of tax you’ll pay varies depending on if you’re a basic, higher or additional rate taxpayer.
The eagle-eyed readers will have noticed that your company has already paid corporation tax on this money, and now you’re paying personal tax. Does this mean you’re paying tax twice? Yes, and no. You are paying two taxes (corporation tax and income tax), but the rates of income tax are reduced to net out the impact of the corporation tax:
Unlike payroll, you don’t need to pay any National Insurance (employers or employees) on dividend income (National Insurance on payrolled income is up to 25.8%).
Walkthrough – getting paid using inniAccounts
Whilst there are more steps to getting paid using a limited company compared to an umbrella company, it doesn’t have to be time-consuming.
That’s the ethos behind inniAccounts: to make running a limited company as effortless as possible. As former contractors and consultants, we know that technology can be used to cut down on admin. Our clients only spend a few minutes per month managing their limited companies, thanks to our innovative tech – and that’s why we’ve won a Queen’s Award for Innovation.
We have three exclusive features, designed to save you time:
You can record your time, mileage and personally-incurred expenses in a single area. This information is used to pre-populate your invoices (speeding up the process, and helping you bill accurately) and automatically triggers the repayment of mileage and expenses in your next payslip. You can also access quick entry from your Android or Apple mobile device.
Every month (or week if you prefer), your payroll runs automatically. You decide how much you’d like to pay yourself, and it runs automatically month in, month out. It’ll calculate all of your employment taxes for you, and tells you what to pay yourself, when. Plus, it will automatically repay your expenses and mileage, meaning you’ll never miss out on saving tax.
Dividends and personal tax planner
We’ve made dividends easy too. When you’re ready to pay a dividend, we’ll tell you exactly how much profit you have after corporation tax. What’s more, we’ll then tell you how much personal income tax you’ll need to pay if you take the dividend. You can change the dividend amount and the taxes forecasts are updated instantly. There’s no more guessing, crossed fingers and unexpected tax bills!
Instead, you’ll get insightful information, in real time – so you can pay a dividend with absolute confidence. This innovation is unique to inniAccounts – no other accounting software does this.
Test drive inniAccounts today, for free
These are just three of the features in inniAccounts. Our end to end software allows you to run your entire limited company, from bookkeeping through to invoicing, pensions, file storage and much more. Our software is backed up by our team of expert accountants, giving you a complete accountancy service.
You’ll be in good company – we’ve helped thousands of contractors and consultants start out, and you can read many of their stories on TrustPilot.
Why not test drive inniAccounts now? You can set up an instant demo which we’ll pre-populate with some example information. Meaning you can explore our award winning features for yourself, right now.Take a demo
Forming a limited company
We’ve made the process of setting up a limited company effortless and we’ll take care of the entire process for you. Your accountant will call you to walk through the structure to make sure it’s right for your circumstances, then we’ll incorporate the company and register it with HMRC. We can even help you open a business bank account if needed.
You’ll need your company in place to sign a contract with an agent or client. Whilst forming a company takes less than 24 hours, it can take a few weeks for your bank account to be opened. That’s why we recommend starting the processes sooner rather than later.
If you’re ready to get started, simply head over to our pricing page now to discover our services.
It can seem counter-intuitive that claiming your business expenses will improve the financial health of your company as they eat into your company profits; but business expenses are deducted pre-tax and VAT, so in real terms you’ll have more cash in your business and your pocket.
In its simplest terms, you should be looking to record any expense, paid by the business, by you, or by your employees that is for physical items or services needed to run the business. The HMRC rule is clear on this; a business expense must be necessary and wholly and exclusively incurred as part of the day-to-day running of your business. But they don’t necessarily have to be related to the specific contract you’re working on. Personal items and expenses must not form part of your expense recording; examples include clothes (non-uniform), dry cleaning and supermarket shopping.
Examples of business expenses include:
- Business equipment – laptops, mobile phones, furniture, storage devices
- Consumables – pens, paper, ink, stationery
- Professional fees – accountants, solicitors, patent attorneys
- Marketing – websites, advertising, hosting fees
- Professional development – membership fees, subscriptions, books, training
- Insurances – professional indemnity, contents, liability insurance
- Travel – mileage, public transport, taxis
Take an annual party
HMRC allows you to reward your employees and their partners with annual events, such as Christmas parties or summer barbecues. You’re allowed to claim up to £150 per person (including VAT), which can include food and drink; and even transport and hotel stays.
What you need to know:
- The event must be an annual event and open to all employees.
- The £150 applies per person, and you can even claim for partners who don’t work for your company – so that’s £300 per couple.
- You can only claim for a maximum of £150 per person, if you claim just 1p over this the whole amount becomes taxable.
- It’s not an allowance – you cannot just claim the amount as-is, you must claim for an actual meal or event and provide receipts.
- It’s not just for Christmas parties – the allowance applies to any annual event. You could even have a Christmas party and a summer event too – as long as the combined total is £150 per head, or less.
Even if you’re a one-person limited company you can still claim back the cost of annual company events – so why not treat you and your partner to a festive soiree or a summer getaway?
Claim for business start-up costs incurred before you formed your limited company
Yes, business set up costs can be claimed as business expenses. Any expenses that are paid for using personal funds should be documented and claimed for when the company starts trading. You do need to remember a few rules when claiming this type of expense:
- Does it meet the business expense criteria above?
- For Corporation Tax purposes, the expense must be no more than 7 years and for VAT purposes no more than 6 months before you started trading. In reality, it would be best to concentrate on the expenses incurred 6 months or less prior to the start of trading.
Transfer personal assets into your company
When you start your business, you may have some existing personal assets that you’d like to transfer into your company. This is a great way of keeping the start-up costs low as you aren’t buying brand new equipment. The main benefit is that the cost of the transfer (what your company pays you for the equipment) is a business expense and therefore has a positive impact on your tax liabilities.
Transferring personal assets to your company is straightforward, as long as you take a pragmatic view of the value of the assets. If you have an asset that was originally purchased for personal use you’ll need to establish the current market value of the asset. You cannot claim the full cost of the asset, unless it was purchased solely for use by your new business. A straightforward method to establish the value of a used asset is to research the second hand market – eBay is a simple way to do this.
Once you have determined the value of the asset, you need to prepare an invoice from yourself to your company listing the items and cost of each separately. If you have the original purchase receipts for the item, it is useful to attach them for your company records.
Appointing shareholders to maximise tax efficiencies
As a part of the company formation process, you need to decide who will be a shareholder in your limited company. If you choose to appoint family members as shareholders, it enables you to distribute company profits to them.
Shares are used to apportion ownership of your limited company. Ownership of shares in a company usually affords the shareholder voting rights and therefore influence over the running of the company. Shares are also used in the distribution of profit from the company; shareholders are paid dividends based on the number of shares they hold. It is a key part of ensuring your business is as tax-efficient as possible so it is important to make sure that the distribution of company shares works for you. Shareholders should be a spouse, a civil partner, or anyone who actively works in the business.
Many contractors and consultants are the sole shareholders within the business, but there is a fair proportion that utilise shares to ‘pay’ other individuals linked with the company in a tax-efficient way. This is a technique used to share dividend income with a spouse, for example, and can maximise unused personal tax allowances. This is particularly effective if your spouse or partner earns less than £50,000 per year.
(If you join inniAccounts, we’ll talk through your company structure to make sure it’s as tax-efficient as possible, based on your specific circumstances).
Download our free book “Tax optimisation strategies for your limited company” where our accountants share more straightforward tips on limited company tax optimisation. In this book you’ll find a number of effective, easy to action and safe tips for cutting the amount of tax you must pay.Download now
We’re a digital accountancy practice, designed by contractors and consultants, for contractors and consultants. Over the last ten years we’ve helped thousands of people leave behind permanent employment and embrace the freedoms of being independent professionals.
With inniAccounts, we’ve build our dream accountancy service – one that’s effortless, insightful and works in real time. Please do explore our website and learn more about our award-winning service. If you have any questions simply call us on 0800 033 7827.