Tax: The basics
As the UK’s favourite umbrella company, we know that our employees don’t want to be bogged down with all the ins-and-outs of tax and PAYE tables, after all, that’s why they use our service!
However, we also know that sometimes you might need to access an overview of the whole tax situation for contractors and be able to delve a bit deeper into the subject. That’s why we’ve put together a series of short guides covering all the basics. So, whether you want to find out more about VAT, calculating tax or your NI contributions, or understand better how insurance, pensions and expenses can be offset against tax, then we’re here to help.
VAT is a “sales” tax that is controlled and collected by the HMRC (HM Revenue & Customs).
If you use an umbrella company then you do not need to worry about VAT. The umbrella company will calculate VAT on your invoices and pay the necessary amounts due to the HMRC.
If you use a Limited company/Personal Service Company and expect to turnover more than £68,000 per annum, you should register for VAT- this simply means that you collect VAT on behalf of Customs & Excise on sales invoices paid by the Agent/Client and must account for this and ensure the correct amounts are paid over to HMRC. Registration takes between 6 – 12 weeks.
Each quarter, the HMRC will send you a green VAT return for completion. All VAT received on your sales invoices minus VAT paid on legitimate company expenses should be paid over to HMRC. VAT is currently 15% on most items although some things are zero rated or low rated at 5%. There is also the concept of the Flat Rate scheme to help simplify the process and you need to decide which method to use when applying for VAT
You can calculate (and repay) VAT on a cash or accruals basis - i.e. based on when you receive VAT from your invoices, or based on invoices sent during the VAT quarter for which you may not yet have received payment. An accountant will advise you which method is best for you.
If you use an agency on a PAYE basis then the agency will be responsible for all VAT processes.
An umbrella company such as Parasol covers all of the VAT implications for you.
Whichever invoicing method you use you will be liable to pay income tax on all money you receive. If you use an Umbrella Company or an agency on a PAYE basis then they will deduct the necessary amounts from your earnings before paying you.
For those using a Limited Company/Personal Service Company you will receive your earnings gross (i.e. including tax and NI) and it is your company’s responsibility for you to deduct and pay the necessary tax.
Assuming you will reach the higher rate (40%) tax band with your combined income from the company, you will have to fill out a self assessment form for income received in each tax year. The HMRC use the details on this form to calculate whether you need to pay any additional tax. Any tax owed is payable by 31st January of the following year. The tax year goes from the 6th April to the 5th April of the following year.
Most contractors pay an accountant to fill out their self assessment form. The normal charge for this is £50 to £150 per year depending on how complex your financial affairs are. Some accountants and Umbrella Companies include this within their services.
If you are running your own Limited Company/Personal Service Company then the HMRC has also introduced 'payments on account' which you should be aware of. If you owe £5,000 in tax for the previous year, you will also have to pay the same amount again (in advance) - i.e. £5,000 + £2,500 in January, then the remaining £2,500 in June.
If you are running your own Personal Service Company and are caught by the IR35 rules, your income will be in the form of a 'deemed salary' after deductions for expenses and National Insurance.
As a Parasol employee all tax calculations are done at source (e.g. when the payment is made) and therefore the complexities of dividends and payments on account are removed. You may still need to complete a Self Assessment return (usually online) and Parasol can help with explaining how this process works.
Contractors, as part of their daily work, provide professional advice that is relied upon by their clients and its suppliers. This means that if mistakes are made or you are deemed to have been professionally negligent, you have a direct financial responsibility to your client for the errors and may be liable for compensation.
Many clients now insist on evidence of contractors having professional indemnity insurance; having this protection proves to your clients that you are professional and responsible in your approach and it should help in you securing future work.
A wide range of insurance policies are available to protect contractors in the event of an accident at work, or claims against them for negligence which will provide you with complete cover and peace of mind.
Parasol include comprehensive Professional Indemnity cover along with public and employer’s liability insurance as part of your employment terms.
The P60 is a statement of how much PAYE tax and National Insurance has been paid during the year. This is issued by your employer (Personal Service Company, Umbrella Company or your Agency) at the end of the tax year.
If you are running your own Personal Service Company you will be a director and, regardless of income, must complete a P11D Return of expenses' payments and benefits form annually. This is not required when using an umbrella company.
The P35 form is a complete summary of everything that relates to your tax and is submitted by Parasol to HMRC each year.
Pensions have long been the most efficient way of reducing tax and NI liabilities. For example; Pension contributions of £6,000 per annum would result in a tax saving of £2,400 for the higher rate taxpayer (assuming 40% higher tax band).
For contractors using an Umbrella Company or those affected by IR35, there are significant benefits of investing in a pension as it will reduce your overall national insurance and PAYE liability. Some Umbrella Companies such as Parasol offer group schemes where pension payments can be made from gross salary saving the NI element in additional to the normal PAYE savings.
There are a wide variety of pension schemes available, it is essential that you get truly independent advice that could save you substantially. It is advisable to always consult an Independent Financial Adviser before you sign anything.
Aside from any “client rechargeable” expenses that are incurred on client related project work that can be charged on, general business expenses can also be legitimately claimed. This has the affect of reducing your tax and NI liabilities. This is because when you are engaged on a contract on a temporary work site, you are deemed to be working away from your employer’s permanent work location (in the case of Parasol, this is our registered office)
There are other conditions around being able to claim expenses and we go through these in full with a Contractor to ensure they are well informed.
For contractors using Parasol we offer an 'expense dispensations’ that saves time with administration (but should not allow expense claims that are not actually spent).
For those contractors using a Personal Service Company falling within IR35 legislation, there is a 5% general allowance for expenses instead of an unlimited allowance.You can still claim 'Schedule E' expenses, such as subsistence and mileage payments in addition. Whilst possible, it is not common practice for the Personal Service Company to have a dispensation, therefore Contractors must keep all receipts and ensure a P11D (tax statement of expenses and benefits) is completed each tax year.
National Insurance is paid in proportion to your salary level (to fund state health and benefit services alongside the state pension)
Parasol will require you to inform them of your National Insurance (NI) number which is needed to ensure your contributions are properly allocated. If you are new to the UK and do not yet have a NI number, then Parasol can assist in explaining the process which relates to an application and usually an interview. We can use a temporary number in the short term but this would potentially not provide you with state benefits until the correct number is allocated.
The rate you receive for the work being done is subject to tax and National Insurance, and like tax; you are allowed to earn a certain amount of pay before NI is due each pay period. There is both Employers NI and Employees NI and Parasol ensure that the correct deductions are made each week or month.
Employees NI used to be capped so that you would not pay more than a certain amount of NI. This is no longer the case and Employers NI is also not capped.Parasol pays over the NI contributions each month to HMRC.
A personal tax code indicates the amount of salary that an employee will earn in any tax year without statutory deductions. For payroll purposes, the amount is divided into either 52 weekly or 12 monthly segments. A personal tax code (as the name suggests) is specific to an individual. So for example, a tax code is often seen as 533L – this means that you can earn up to £5330 per annum before tax is paid. You must remember though that this is then divided by 52 (weekly) or 12 (monthly) so becomes the amount you can earn each period before tax is paid
A P45 is a statement of earnings and tax payments from a previous employer and is needed to ensure you are on the correct tax code when you change jobs. If no P45 is available then a P46 can be issued to receive a full code from the tax authorities. Parasol can assist with this and explain how a P46 affects your early payments.
