No one wants to pay more tax than they have to so it’s important to be aware of the day to day opportunities that you can use to help towards minimising your tax bills legitimately.
As individuals and business owners we are subject to an array of complicated tax rates, thresholds and rules. A good understanding of the foundations of the tax system will help you avoid overpaying HMRC unnecessarily.
Tax is a complicated subject. Always seek professional advice before embarking on any tax planning strategy.
Overview of Taxes
The salaried income you and your employees receive is subject to Income Tax, which is deducted from you gross salary payment during payroll. Currently (for the 2023/24 tax year) most individuals can earn £12,570 per year free of Income Tax; after this, Income Tax (in England) is deducted at a rate of 20%, 40% or 45%, depending on your earnings.
Salaried income is also subject to National Insurance payments, which are paid by both the employee (deducted from their gross salary) and the employer (an additional expense on top of the salary). National Insurance is a little more complicated to calculate than income tax, however in most cases the employee must pay 12% on annual earnings over £12,570 and the employer must pay 13.8% of the annual earnings above £9,100.
Qualifying for National Insurance benefits
Aside from partly funding the NHS, National Insurance is used to pay for a number of benefits, including: jobseekers allowance; incapacity benefit; bereavement benefits; maternity payments and state pensions. If your earnings are below £6,396 per year you may not qualify for all of these benefits.
VAT (Value Added Tax)
If your company turns over £85,000 or more per year (for the 2023/24 tax year) you must register for VAT and make the appropriate charges to your clients. VAT is charged on top of your net invoice amount – for example if you charge a client for 10 days work at £200 per day your invoice will total £2,400 including VAT (at 20%).
As well as charging clients VAT you can also claim back the VAT from purchases your company makes – you only pay the difference between the VAT you charge to your clients and the VAT you pay via purchases.
Corporation Tax is payable annually and based on the profit that your company makes. Your profit is your company’s income minus its expenditure (including salaries paid to employees but excluding dividends paid). The current Corporation Tax rate for small companies is 19% and this increases once profits exceed £50,000, and is payable on your profit each year. The Corporation Tax needs to be taken into account to determine what profits remain available to pay to the shareholders. This remaining amount can be issued to the shareholders as Dividends during the year or at the end of the year. If your company has made £20,000 profit, up to £16,200 can be withdrawn as dividend payments. You can find more information on Corporation Tax changes from 1st April 2023 here.
Making tax-efficient withdrawals from a business
During the day-to-day running of your business, you’ll need to decide how best to manage your money in order to reduce your tax burden. The following list details how money can be withdrawn from your business, listing the methods from the most tax-efficient to the least:
- Legitimate business expenses – expenses that are incurred during the running of your business with no personal element can be repaid without being subject to tax. Common expenses include mileage to and from a client’s office, sustenance whilst working away from home, hotel stays and office consumables.
- Payroll up to your Personal Allowance (commonly £12,570) – by making use of your Personal Allowance your income will not be subject to Income Tax, you will however pay National Insurance on income above £9,100.
- Dividend payments – you can withdraw profit from your company in the form of dividends. These payments can be made after deducting corporation tax from your company’s profit.
- Payroll above your Personal Allowance – once you earn an annual salary above your Personal Allowance you will be subject to Income Tax at a rate that falls between 20% to 45%, plus employees’ and employers’ National Insurance.
Personal expenses / benefits in kind
It’s also possible to pay personal benefits to employees – such as providing assets for personal use, health insurance or gym memberships. However, the taxation rules around these benefits can be quite complicated and we strongly suggest you have an in depth discussion with your accountant before considering them.
Tax saving tips for contractors and consultants
1. Maximise legitimate expenses
Running a business leads to many expenses being incurred, including travel costs, insurance, telephone bills and internet fees. Given that expenses can be offset against company profits, thus reducing corporation tax, you should ensure you’re recording and claiming all legitimate business expenses. In particular, don’t forget the following:
- Mileage – you can claim for the mileage incurred when travelling to and from a client’s office, and with tax-free rates up to 45p per mile this soon adds up. Remember to include your car parking and congestion charges, but to stop claiming once your workplace is no longer considered temporary due to the 24 month rule.
- Carry passengers – you can claim 5p per passenger per business mile for carrying fellow employees in a car or van on journeys that are also work journeys for them. Note that the payment can only be made if the journey is specifically for carrying passengers.
- Sustenance – you can claim for meals and refreshments purchased whilst working with a client.
- Accommodation – if you’re working away from home you can claim for accommodation costs, such as hotels or B&Bs.
- Computer hardware and software – you can claim for IT equipment so long as it is purchased solely for business use.
- Business phones / broadband – you can claim for one mobile phone per employee and broadband costs when they are used for business purposes. If the phone and contract are in the name of the company then the whole amount can be claimed as a business expense, even if you use the phone for personal use as well.
- Eye tests – if you are required to use a computer for work you may be able to claim back the costs of an eye test.
- Professional memberships and subscriptions – HMRC publishes a list of recognised professional bodies for which you can claim back the membership fee.
2. Claim for use of home as office
If you primarily work at your client’s site and only use your home office for managing your business, you can claim £6 per week (or £26 per month) for incidental home expenses. So if you simply use your PC at home to tidy up a few loose ends and you do not qualify as having a ‘dedicated home office’ that you conduct business from, you can claim up to £312 per year.
So you don’t miss out making this claim from your company you can use the Regular payments & savings feature. This will allow you create a recurring payment, say once a year for £312 or more frequently if you prefer. The regular payment created will then place a pending payment into your bookkeeping and you can simply pay yourself personally the sum from your business account and mark the pending payment as paid. Alternatively you can enter the amount into your Quick Entry area and reclaim them on a payslip.
You do not need to keep any records of the household expenses you are claiming when reimbursing these expenses.
3. Pay yourself a small salary and take profits as dividends
By maintaining a small salary you can reduce your Income Tax and National Insurance bill by using your tax-free Personal Allowance. By paying more out as dividends you will be paying Corporation Tax that ultimately is lower than the Income Tax and National Insurance rate you would pay if you had a larger salary.
It is not uncommon for a spouse to have shares and hence receive dividends when they are paid. The advantage of this approach is it may allow use of any unused personal tax allowances.
4. Maximise company pension contributions
One of the easiest methods to save tax is to put money into a pension scheme. This will either reduce the corporation tax paid on the profits or you’ll receive tax relief on your personal contributions depending on the selected pension scheme.
Should you need to setup a pension or review your current arrangements, we recommend you discuss this with an Independent Financial Advisor. We can provide you with any information they require to ensure you get the best advice possible from them.
5. Opt for contracts where you can operate outside of IR35 legislation
Understanding and working outside IR35 is a good way of keeping your tax bill to a minimum. By understanding IR35 and seeking contracts that comply, you will inevitably reduce your tax burden. Take a look at our comprehensive IR35 guide here.
6. Structure your remuneration tax efficiently
It’s a sensible idea to put money aside within your business for a period when you may decide to have a break or are waiting for your next contract. If you were to withdraw all your earnings it could force you into a higher rate tax bracket, so why not reduce your earnings and ensure greater peace of mind by keeping as much profit as possible within your business?
7. Review your VAT method
It’s important to occasionally review the VAT method used by your company; this will both help you to stay on top of VAT rate changes and keep your tax bill as low as possible. For example, consider if you would be better moving away from flat rate VAT to the standard or cash accounting scheme or vice versa.