Contractor Tax - A Guide To Your Options

'Contractor Tax' is actually a simplistic expression used to describe exactly how contractors account and pay their taxes and National Insurance. There are many companies that use contractors with regard to specific duties or to help with special projects. The ramifications for Contractor Tax are wide ranging and need to be considered cautiously. The main options for contractors are:-



Self Employed



A self employed contractor will pay 'Contractor Tax' in much the same way as a normal self-employed person, for instance a plumber. A record of the costs incurred, materials etc must be maintained as well as summarised on the annual tax return. The self employed person has to raise their very own invoices as well as send these to customers.



Furthermore the self employed person will have to sign up for VAT in case your turnover is much more than $73,000 (2011/12). VAT is accounted for as well as paid to HMRC every 3 months, it is due even if the bill has not been paid at the time the VAT return is posted.

 

The main pitfall with this choice is that many companies will only employ a specialist contractor working for a limited organization. HMRC uses tests to establish that the contractor is truly self-employed and not a disguised employee of the client company which has serious implications on the level of Contractor Taxes paid.



Setting Up Your Very Own Company



A business can be started fairly simply by purchasing one 'off the shelf'. The company will require its own bank account. Once again if the turnover surpasses $73,000 (2011/12) you have the additional problem of accumulating and paying over VAT.



While this option may allow the contractor much more freedom to operate their business the way they would like, the additional obligations make it necessary for more detailed records to be kept and may involve additional expenses. However the quantity of Contractor Tax paid can be reduced through the use of dividends instead of paying a high salary.



The main consideration for contractors is actually passing the tests to exhibit that the person running the company is an independent contractor and not considered a disguised employee of the client business. The failure of these tests could incur additional costs and potentially big penalties around the additional Contractor Tax due. When there is a dispute with HMRC the costs of defending the actual independent contractor status can be high and cannot be reclaimed.



Umbrella Organization



There is a rise in the use of Umbrella businesses when loopholes utilized by Contractors to lower their Contractor Tax were decreased by HMRC.



The way it works is that a service provider becomes an employee of an Umbrella company. Every week or month the contractor completes a time sheet and details their own allowable costs. The Umbrella Company invoices the client company. When the invoice is paid, the actual Umbrella Company will subtract the contractor's taxes and National Insurance just before payment is made to the contractor's banking account. This simplifies the entire process and helps to ensure that the right degree of Contractor Tax is paid out.



The extra benefit is the fact that working through an Umbrella Company ensures that there will not be a test to ensure that the contractor is not a disguised employee.