Many individuals working as sole traders and contractors have been forming limited companies to benefit from flexible tax planning. Operating as a company rather than a sole trader has several benefits that deserve consideration.
Choosing to form a company rather than operate as a sole trader has been common practice for many years. As sole traders businesses grow it is often recommended that being a company is a more suitable legal format. However, over recent years there has been an increase in contractors and professional service providers forming companies to benefit from advantages in tax planning.
Registering a company to contract with an organisation that requires your services has several benefits over contracting directly as a sole trader. As a director and owner of the company, there is greater flexibility in how you are paid and withdraw expenses and profits.
Benefits of contracting as a company
Expenses. The company can claim back expenses on a range of activities. This includes business travel, training courses, purchasing equipment, entertaining clients, subsistence expenses (e.g. lunch at a temporary workplace), professional subscriptions, telephone and internet costs (home and mobile).
Higher pay than employees. In comparison to an employee, contractors are typically paid more money. This is because the organisation buying your services will have reduced costs and liabilities.
Increased take-home pay. Companies are able to pay the shareholders dividends as well as PAYE. This can reduce personal taxes paid depending on circumstances.
Income splitting. It is possible to split the income with a partner or spouse when they are on a lower tax rate. Operating a company allows you to issue shares to more people and split the distribution of profits.
Deferred income. If you anticipate one year’s income to be significantly higher than the next year, it may be beneficial to delay extracting profit from the company. A large contract or payment one year may push your earnings into a higher tax bracket. If the following year you expect earnings to be lower keeping the money in the company and only paying corporation tax that year may reduce your personal tax next year.
Working flexibility. Many contractors are able to provide service to more than one organisation at the same time. Working for different companies can provide a greater variety of work and working environments. It may also be possible to work from home or on the move.
Limited Liability. It has long been recognised that limiting your liability is a benefit of forming a company.
Disadvantages to contracting as a company
- There is no sick-pay or holiday pay. Time off is time unpaid so manage holidays and absence around expected workloads.
- Contacts may be short-term and you may need to find the next paid contract.
- You will need to file accounts and company tax returns. You may need to register for VAT if invoicing above the registration threshold during a 12 month period. (An accountant can manage this for you to remove the burden).
- You may need to operate PAYE, but there are many cheap online services for this or your accountant can handle this.
- Economic conditions may make finding contracts more difficult if organisations are ‘cutting back’.
- IR35 rules need to be considered
Contracting as a company has become increasingly popular due to the flexibility it offers. If you are not sure whether this is the right solution for you then we recommend you seek advice from an accountant or tax advisor.