Limited Company Taxes
As the director of a limited company, you are responsible for ensuring that your company submits returns and pays all taxes by their respective due date. You will also be required to submit a tax return to HMRC containing all of your personal income, and pay over any tax arising on that income.
This section of our site will outline the various tax obligations that you will have as a director. This page covers the following topics:
IR35
IR35 is a piece of anti-avoidance legislation aimed at preventing disguised employment; this is where someone who would otherwise be employed performs their duties through a company and enjoys the tax benefits associated with this.
An example of IR35
An employee would leave his employment on a Friday afternoon and return to work the following Monday to do the same job but not as an employee of the original employer. Instead, he would be employed by an intermediary (a personal service company of which he would be a controlling shareholder/director) through which his services would be supplied to the original employer. The intermediary would invoice the original employer for these services and would receive a gross payment.
Through coming to the above arrangement the original employer would avoid paying Class 1 NIC at 13.8% and the (former) employee could arrange his payments between salary and dividends in order to minimise his tax and NI liabilities. The government, therefore, introduced anti-avoidance legislation known as IR35 in April 2000 with the purpose of countering this problem.
How could IR35 affect you?
If you are caught by the legislation then IR35 will prevent you from using traditional tax-planning techniques (small salary and high dividends) to minimise your tax obligations – instead, it will require you to pay almost all of your fee income out as a salary so that you are taxed essentially the same way as an employee would. The IR35 status of an engagement is determined by looking at whether the engagement would be one of employment or self-employment in the absence of the service company.
How to determine employment status
There is no definition in law of what constitutes employment or self-employment - we, therefore, refer to case law judgments to establish the components of what makes up employment or self-employment.
The leading case in this area is Ready Mixed Concrete (1968) - it was found in this case that in order for employment to exist, there must be three factors: Control, Personal Service, and Mutuality of Obligation. If any of these factors is absent then the engagement cannot be considered one of employment and the individual will be seen to be self-employed.
Control
Control concerns what has to be done, when and where it has to be done, and how it has to be done. In an employment relationship, each of the above is dictated to the employee, if a person maintains autonomy over these things it would indicate self-employment. If the client can move the contractor according to their priorities or exercise significant control over how they perform their duties (through supervision, monitoring, checking, and appraisal) as opposed to complete freedom over how to complete a project, then they would be seen as employed rather than self-employed.
Personal Service
The need for one particular person to carry out a role is an essential element of a contract of employment. It follows that if a contractor has the freedom to choose whether to perform his/her duties themselves or to hire somebody else to do it (on a reasonably unfettered basis) for them, is self-employed.
Mutuality of Obligation
The expectation for continuous work to be provided to a person and the expectation for all work provided to be completed characterises an employment relationship. If there is a clause contained in a contract setting out an obligation for the client to offer further work and for the contractor to accept it, there would be a mutuality of obligation in the contract and it would be caught by the IR35 legislation. ‘Rolling contracts’ or indeed contracts that are continually renewed could fail this test.
The actual working practices would be examined along with the contract under which the person is engaged. It is important that the working practices of the contractor are reflected in the contract. More and more we are seeing the contract being overlooked by HMRC Inspectors and reliance being placed on the working practices themselves to determine the IR35 status.
For IR35 compliance, we strongly recommend that you engage with a team of contract law specialists who can undertake a full review of your contracts and working practices for the purpose of IR35. In having such a review prior to signing contracts, it gives you the opportunity to make amendments to improve your IR35 position - you will also have evidence of your IR35 position having been considered by a professional which could be advantageous if HMRC make an inquiry into this later on.
For more information on IR35, please visit our Complete Guide to IR35.
VAT
VAT is a tax on a company’s turnover; it is added to the value of the fees invoiced out to your clients, currently at 20%. Therefore, if your fee for providing a service was £1,000, you would add £200 (£1,000 x 20%), making the total value of the invoice £1,200.
It is compulsory for a business to register for VAT if the annual turnover will exceed £85,000 (2020/2021 rate), though it may be beneficial to register voluntarily if the business turnover is below this threshold as you may be able to benefit from using the Flat Rate Scheme. On this scheme, you will continue to charge VAT to your clients at 20% of the net invoice value but will pay VAT over to HMRC at a lower percentage which is determined by the nature of the trade undertaken by the business.
If your company is VAT registered, you will be required to charge VAT on each of your invoices, submit quarterly VAT returns electronically by the relevant due date, pay any VAT owing by the due date, and keep a VAT account within the company’s accounting records.
An example of VAT
Income derived from a £1,000 invoice by a company using the scheme is illustrated below:
| Net Charged: | £1,000 |
| VAT Charged: | £200 |
| Gross Charged: | £1,200 |
| VAT Payable @ 14.5%: | £174 |
| Saving (£200 - £174): | £26 |
The income to the company is boosted by 2.6% as a result of being on the Flat Rate Scheme.
Corporation Tax
Corporation Tax is charged on the profits made by a company for a specific period. The current rate is set at 19%.
Shortly after a company is formed, HMRC will issue a notice "Corporation Tax – information for new companies (CT41G)” out to the registered office of the company, this is an instruction to register the company with HMRC for Corporation Tax.
A company must submit a CT600 (company tax return) form electronically (via iXBRL) to HMRC; this must reach HMRC within 12 months of the period end for the CT600. In most cases, the CT600 period is the same as the accounting period. However, in the company’s first year, it may be slightly earlier if the accounting period is longer than 365 days (the maximum length of a CT600 period).
The company must pay its Corporation Tax liability within 9 months and 1 day from the CT600 period end.
Self-Assessment Tax Returns
The Self Assessment Tax Return must be completed if any of the following applies:
- You are a company director who is not taxed under PAYE;
- You have income from a self-employed trade;
- You have un-taxed income;
- Your income is in excess of £100,000;
- You have capital gains tax to pay;
- HMRC has sent you a tax return (for whatever reason);
- You have an income of £10,000 or more from savings and investments.
The self-assessment return requires you to detail all of your income (typically salaries, in, interest, and dividends) and any tax which has been paid (or deemed to have been paid) on the various forms of income. The income tax year runs from 6th April to 5th April, this is the period for which HMRC requires the return to be prepared.
The tax return is due to be submitted to HMRC by 31st January following the end of the tax year, this is also the date that any tax owing is due to be paid.
Payments on Account
If the amount owing from self-assessment comes to £1,000 or more, then you will need to make a payment on account for the following year. The payments on account are made in two installments, the first on 31st January and the second on 31st July. Any payments made on the account will then be offset against the total tax liability for the following year.
The level of salary that the company pays to you is an important consideration when it comes to tax planning. Directors are exempt from the National Minimum Wage legislation where there is no written contract of employment in place – this gives you the freedom to set your salary at the most tax-efficient level.
The most tax-efficient salary (in most cases) is one set at the National Insurance threshold (£9,568 for 2021/22), at this level, there will be no income tax to pay, and there will also be no employee's or employer's National Insurance liability. The salary will also be treated as a deductible expense for Corporation Tax purposes.
In order for salary to be treated as a deductible expense for Corporation Tax purposes, the salary should be at a commercial rate equal to that which would be paid to a third party in an agreement made at arm’s length. We do not recommend paying a salary to non-fee-earning relatives or friends, if this came under HMRC scrutiny then it is likely to be disallowed.
Salary comparison
This table shows the different levels of take-home pay achieved based on three situations: all profit taken as a salary; our recommended salary topped up with dividends; and no salary with all profit taken as dividends.
| High Salary | Low Salary | No Salary | |
|---|---|---|---|
| Turnover | £75,000 | £75,000 | £75,000 |
| Salary | -£66,952 | -£8,632 | £0 |
| Employers NI | £8,048 | £0 | £0 |
| VAT Payable @ 14.5%: | £1,000 | £1,000 | £1,000 |
| Profit before tax | £0 | £66,368 | £75,000 |
| Corporation Tax | £0 | £12,610 | £14,250 |
| Dividends | £0 | £53,758 | £60,750 |
| Salary | £66,952 | £8,632 | £0 |
| Dividends | £0 | £53,758 | £60,750 |
| Income Tax | -£14,281 | -£6,689 | -£6,156 |
| Employee's NI | -£5,303 | £0 | £0 |
| Take-home | £47,368 | £55,701 | £54,594 |
Pensions
Payments made into an employee’s pension plan by a company are deductible for corporation tax. To qualify, the pension contributions must be ‘wholly and exclusively’ for the purpose of trade rather than for the benefit of the employee/director; whilst the guidance on this is a little ambiguous, we advise that if the overall salary and pension does not cause the company to generate a tax loss then the contributions should qualify for tax relief.
There is an annual allowance of £40,000, which is the total amount of contributions that can be made to an individual’s pension fund (per pension input period); if total contributions (made up of both company and personal contributions) exceed this amount then there will be a tax charge on the employee at their marginal rate.
We would advise you to consult with a pension advisor prior to making any pension arrangements.
If you take our recommended salary then it is more tax efficient to make use of the tax relief on personal pension contributions before making them from company funds. The reason for this is that your basic rate band will be extended by the gross contribution (after basic rate relief has been claimed by the pension provider), an £80 pension contribution made personally allows you to take an extra £90 in dividends before reaching the higher rate threshold.
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