Corporation tax for contractors: demystified

Corporation tax in the UK is charged on profits made by companies which include trading profits, investment income, and capital gains.

It’s the first of these - trading profits - which will mostly concern Free-Work readers who use a limited company to operate as a freelance technologist and in turn, their concerns will likely be on the size of the CT bill. Let’s look at it all, writes Teodora Dimitrova, founder of Chart Accountancy.

Calculation of Taxable Profits

With effect since April 6th 2023, an announcement at Spring Budget 2021 by the then-chancellor Rishi Sunak, resulted in major reform to corporation tax for contractors:

1) The main rate of corporation tax will rise from 19% to 25% for companies with profits over £250,000.

2) An introduction of a separate rate for companies with profits under £50,000 will be set at 19%.

3) A tapered rate will apply for companies with profits between £50,000 and £250,000, with the tax rate to gradually increase from 19% to 25% -- as profits rise.

Under this announcement, a contractor’s limited company with £50,000 profits now pays 19% corporation tax compared with a limited company contractor whose profits of £100,000 now pays 22.75%.

Where such a Personal Service Company contractor has profits of £250,000 and above, they pay to HMRC a hefty 25%.

This now-in-force corporation tax regime means an increase of at least £15,000 for any incorporated business with profits of £250,000 and above.

In short, since April 6th 2023, there’s been a significant tax increase for some limited companies, many of which operate in the digital and tech sectors.

What is the UK’s corporation tax rate?

Corporation tax is tax levied on any and all company profits. All UK-based companies are required to pay ‘CT’ on their annual profits from the UK and abroad. So, if you own a limited company that is based in the UK, you’ll need to pay corporation tax on the profits that your company makes.

The 25% main rate is payable by companies with taxable profits above £250,000.

As outlined, a ‘small profits rate’ exists for companies with profits of £50,000 or below, meaning they will pay 19%.

Companies with taxable profits between £50,000 and £250,000 may be able to claim ‘Marginal Relief,’ which provides a gradual increase in the CT rate between the ‘small profits rate’ and the main rate. This allows those companies to potentially reduce the rate they pay from the 25% main rate.

Corporation tax return deadline and payment

1) Filing Deadline: Companies must file Corporation Tax Return CT600 with HMRC within 12 months of the end of their accounting period.

2) Payment Deadline: Corporation tax must be paid within nine months and one day after the end of the company's accounting period. If your accounting period ends on March 31st, your corporation tax will be due by January 1st.

If your corporation tax liability is not paid on time, HMRC will charge Late Payment Interest at 7.75% rate.

More positively, if you pay your corporation tax early, you can earn interest from HMRC. The current interest rate, which has increased since August 2023, is 4.25%.

For companies with taxable profits exceeding £1.5 million separate rules apply. For help with complex taxation, speak to an accountant like us for tailored guidance. But as a general rule to abide by, you’ll ordinarily have to pay HMRC penalties if you don’t file your company tax return on time.

Be aware of HMRC penalties

If you are just a single day late filing your company tax return, you will be charged £100 penalty.

If you are three months late to file your return, you will be charged another £100.

At six months late, HMRC will estimate your corporation tax and add a penalty of 10% applied to the unpaid tax. And at 12 months late, you will be charged another 10% penalty.

Calculation of Taxable Profits

As a contractor, you will likely already have an accountant who is working with you to help you calculate your ‘Taxable Profit.’

You will need to follow basic accounting rules:

1) Calculate your Taxable Turnover – for example the total sales from your tech consultancy’s services.

2) Allowable Expenses: Legislation disallows any expenditure not incurred ‘wholly and exclusively’ for the purposes of trade. But positively, all allowable deductions reduce the taxable profit. Remember, ‘wholly and exclusively’ expenses are incurred for the sole purpose of running the business.

3) Disallowed Expenses: Not all expenses are allowable. For example:

• expenses that have a dual purpose for business and personal use.

• expenditure on business entertainment or gifts is not allowable as a deduction against profits, even if it is a genuine expense of the trade or business.

• you cannot claim for things that you use for both private and business use, such as rent or broadband access.

Three ways to lower your HMRC corporation tax bill

As a limited company contractor, you are likely to invoice your clients for your time to deliver the services agreed.

You will however pay yourself a salary which might not even exceed the personal tax allowance as a tax-efficient measure.

Therefore, as a contractor it is important to understand which expenses you are entitled to claim as allowable. This is important to consider as all allowable expenses will reduce your profits and therefore your corporation tax bill from HMRC - in three key ways.

1. Tax Planning

An accountant who works closely with your company can help with efficient tax planning strategies to minimise your tax liability, utilise available reliefs and allowance – and should help you meet filing deadlines!

 2. Claim Allowable Expenses

• Home Office Expenses: A proportion of your home expenses if you work from home, including utility bills, and business phone calls.

• Computer and Software

• Costs for stationery, postage, and other office supplies.

• Office Equipment - like a desk and a chair.

• Travel, Meals and Accommodation expenses

• Advertising

• Website costs

• Trivial Gifts – capped to £300 in total value per director -- but consult your accountant as the rules are tightly framed.

• Professional Indemnity, Public Liability and IR35 Insurance

• Training expenses - allowable business expenses for training that helps you: improve skills and knowledge you currently use for your business; keep up-to-date. But be aware, costs associated with a degree course will not be an allowable expense.

• Other expenses: Gifts to clients can be allowable if within the current limit of £50 per recipient per year -- but not food, drink, or tobacco.

• Clothing: Protective clothing required for your work.

• Uniforms - where the employee or director is required by his or her duties to wear it and must bear the cost of it, can be an allowable expense.

• Charity donation – As a limited contractor, you can effectively pay less corporation tax if you gift money to a registered in the UK charity.

• Research and Development (R&D) Credits: If applicable, you can claim expenses for qualifying projects to reduce your tax liability.

3. Consider making an employer pension contribution

If you are ready to invest in your pension, this can help to make sure you keep securing your future whenever you decide to stop working. If you have your own limited company, it could also help you save.

As limited company director, you are deemed employed. You can make employer contributions to your pension from your company account. Employer contributions can be treated as a business expense so you will reduce your corporation tax .

Additionally, if the pension contributions are made instead of paying yourself the same amount in a salary, then you and your company will save from having to pay National Insurance. As a director, you will also save income tax on that amount until you access money from your pension where the earliest is when you reach at least age 55 (rising to age 57 from 2028).

The annual pension contributions limit is £60,000 plus you can ‘carry forward’ any allowance you haven’t used from the three previous tax years.

As a director of your company, your pension contributions will ordinarily be allowable businesses expenses provided they are incurred ‘wholly and exclusively’ and during the course of their trade.

In addition, should you employ staff, it is important to ensure that you are making similar pension contributions to others in your company who are doing work of similar value.

Keeping your records and demonstrating compliance

Businesses (including limited companies paying corporation tax) are mandated to use HMRC-recognised Making Tax Digital (MTD) software to keep digital records and file VAT returns.

When it comes to filing your MTD VAT return, many contractors choose to use Xero, as the software streamlines the process of complying. It is important to keep detailed records and receipts for all expenses you claim, and software such as Xero can automate this function.

But whether it's VAT or CT, the UK's tax frameworks can be complex, so we recommend consulting with an accountant regularly to ensure your liability is as low as possible thanks to claiming all allowable expenses while ensuring updates to your records are categorised correctly. Good luck!