Limited Company Structure for Tax Efficiency
Tax Implications of Operating as a Limited Company for Contractors
The idea of setting up a limited company as a contractor can be daunting, especially when it comes to being tax-efficient. You’ve probably heard that the limited company structure is a tax-efficient one, and that’s why a lot of contractors set up their own companies. But, you can’t simply set up a company and expect your tax responsibilities to fall into line. If you want to contract in a tax-efficient way, you need to know how to use a limited company structure to your advantage.
At Go Limited, we know all there is to know about operating through a limited company, and that includes how to approach contracting in a tax-efficient way. You don’t want to end up paying more tax than you need to and you don’t want to run the risk of underpaying, but our experts are on hand to help.
Sole Trader or Limited Company Tax: Key Differences
There’s a lot riding on the way your business is structured, which is why a lot of contractors opt to set up a limited company. Regardless of the services you provide, and the clients you work with, operating through a limited company tends to be the most tax efficient way to approach contracting. There are various reasons for this, but utilising a limited company structure is usually more tax efficient than being a sole trader or freelancer.
Tax Treatment
As a sole trader, you pay income tax on all of your profits. There are various tax bands - ranging from 20% on income over £12,570 all the way up to 45% for additional rate taxpayers - and National Insurance Contributions (NICs) to think of. All of these costs quickly add up. But, as a limited company contractor, your business pays Corporation Tax on its profits, which is currently set at 19% for small businesses with profits under £50,000 and 25% for larger, more profitable businesses. You also have the chance to pay yourself in dividends as a limited company contractor, which are taxed at a lower rate of 8.75% as a basic rate. This reduces your tax liability and leaves more money in your pocket.
Legal and Financial Separation
Another main difference between being a sole trader and utilising a limited company structure is linked to whether or not you’re separate from the business. If you’re a sole trader, you are personally liable for any debts or legal claims. If the business owes money, that means you owe money, and your personal assets are at risk if debts need to be repaid. If you’re a limited company contractor, you and your business are separate legal entities. This means that the company is liable, not you.
Administration and Setup
Regardless of how you approach contracting, you’re going to have admin to take care of. But, if you utilise a limited company structure, you might have slightly more to do. Sole traders have simpler reporting, and all that’s required of you is sending an annual Self Assessment to pay the tax you owe. When you set up a limited company, you need to file annual accounts and confirmation statements with Companies House, file tax returns and maintain proper bookkeeping. Sole traders have less admin, but are taxed more heavily as income grows.
As you can see, there are some big differences to the way the sole trader and limited company structures work. It’s also clear to see why many contractors take the limited company route, especially when it comes to tax-efficiency.
Limited Company Tax Benefits: Use the Structure to Your Advantage
Setting up a limited company offers several distinct tax advantages that allow you to retain more income and reduce your tax bill. If you make the most of these tax advantages, you’ll find it easier to contract in a tax-efficient, cost-effective way. As a limited company contractor, you can draw a low salary - typically just above the NI threshold - and take the remainder of your income as dividends. This allows you to minimise your NICs and pay a lower tax rate on dividends than on equivalent salary income. When you do this, your combined tax liability is significantly lower than if you'd received the entire amount as salary. This reduces your tax bill, keeping more of your hard-earned money in your pocket.
You also have the benefit of not having to draw all of your profits. When you use a limited company structure, funds can be retained in the company, which you can then use to reinvest or draw later in a tax-efficient year. This helps you spread your income during low-revenue periods and avoid pushing yourself into higher tax brackets. Organising this does take some limited company tax planning, but the financial benefits really do pay off.
Boost Tax Efficiency with Deductible Expenses for Your Limited Company
Another major advantage of limited companies is the ability to claim a wide host of allowable business expenses. These reduce your business’ taxable profits, which means that you pay less Corporation Tax and keep more money in your business. A deductible expense is a legitimate business cost incurred wholly and exclusively for the purpose of running your business, such as anything you spend on raw materials, accountancy and office costs.
Common Tax-Deductible Contractor Expenses Include:
- You can claim accountancy and legal fees as tax deductible.
- Office costs, including a portion of home office bills if you work from home, are allowable expenses. This includes rent and bills.
- Mobile phone and broadband costs can be claimed as limited company expenses.
- Business insurance, such as professional indemnity and public liability, are tax deductible.
- You can claim training and development as allowable expenses, as long as its relevant to your work.
- Travel and subsistence are tax deductible, including fuel, mileage, train fares and accommodation for business trips.
- Software subscriptions are allowable expenses, which means you can claim for project management and antivirus software.
- Marketing and advertising costs are allowed, as these are spent solely for business purposes.
The cost of your business expenses quickly adds up, so be sure to claim for everything you’re allowed to. You don’t want to spend a lot of money on something for your business, and then forget to claim. The more you accurately record and claim, the more efficient your business becomes.
Don’t Underestimate the Importance of Limited Company Tax Planning
Making the most of having a limited company structure for tax efficiency doesn’t happen on its own, nor does it happen overnight or by accident. You need to make time for tax planning. You need to plan, keep accurate records and make the right decisions.
- Timing of Dividends - There’s no denying that paying yourself in dividends is tax-efficient and cost-effective, but that only happens if you take them at the right time. Plan when to take dividends to stay within lower tax bands.
- Pension Contributions - Annual pension limits allow you to build wealth while reducing Corporation Tax liability, so make the most of the options available to you as a contractor. This is something a limited company accountant can help you with.
- Expense Tracking - It’s a lot easier to claim the right expenses if you track everything accurately, and there’s a lot of accounting software that can help. Use software to track expenses in real time. This ensures nothing is missed and keeps you prepared for tax season.
- IR35 Compliance - If your contracts fall under IR35, you might be taxed like an employee. IR35 compliance is key for retaining tax efficiency, particularly in umbrella roles, so make sure you understand how to stay compliant.
- Working with an Accountant - When it comes to utilising a limited company structure for tax-efficiency, you’re not alone. A good accountant who understands limited company contractors will help you to identify savings opportunities, keep you compliant and navigate tax planning.
Proper planning allows you to legally structure your income and outgoings in a way that maximises your earnings, whilst also reducing your tax liability and setting you up for financial security.
Though being a sole trader is simpler, the limited company route offers more tax efficiency for most contractors. From lower overall tax rates to greater flexibility in how income is taken, the structure allows you to retain more of what you earn. Whether you're considering switching from sole trader status or you’re already operating through a limited company and you want to improve your tax-efficient, Go Limited is here to help.
FAQs:
Utilising a Limited Company Structure for Tax Efficiency as a Contractor
What is a limited company, and how does it work for contractors?
A limited company is a legal business structure that separates the business from its owner. For contractors, this means you can operate as a director and shareholder of your own company. You invoice clients through the company and pay yourself a mix of salary and dividends, which can be more tax-efficient than PAYE employment.
Why is using a limited company considered more tax-efficient?
Operating through a limited company allows you to pay yourself a small salary (within tax-free thresholds) and take the rest of your income as dividends, which are taxed at lower rates. You can also claim a wider range of business expenses and potentially reduce your National Insurance Contributions.
What are the main tax advantages of a limited company?
- Lower tax on dividends vs salary
- Ability to split income with a spouse (if they’re a shareholder)
- Corporation Tax is typically lower than higher-rate personal income tax
- Claiming legitimate business expenses
- Potential for pension contributions through the company
Are there any downsides to using a limited company as a contractor?
Yes. You’ll have more administrative duties, such as filing annual accounts and tax returns. You may also face scrutiny under IR35 legislation, which could reduce your tax benefits if HMRC deems you a ‘disguised employee.’
How does IR35 affect tax efficiency for limited company contractors?
If your contract is ‘inside IR35,’ you must pay tax and National Insurance similar to an employee, which reduces the advantages of a limited company. However, if your contract is ‘outside IR35,’ you retain full control over how you pay yourself and can maximise tax efficiency.
Can I still claim expenses if my contract is inside IR35?
Your ability to claim expenses becomes more limited. For example, travel and subsistence costs are usually not claimable if you’re inside IR35 and working at a single client site.
What kind of expenses can I claim through my limited company?
You can typically claim:
- Travel and mileage (if outside IR35)
- Equipment and software
- Accountancy fees
- Mobile phone and internet (proportional to business use)
- Business insurance
- Pension contributions
- All must be wholly and exclusively for business purposes.
How do I set up a limited company as a contractor?
You’ll need to:
- Register the company with Companies House
- Open a business bank account
- Register for Corporation Tax, PAYE, and potentially VAT
- Get professional help from a contractor accountant (strongly recommended)
Do I need an accountant to run a limited company?
It’s not legally required, but highly recommended. A specialist contractor accountant can help you stay compliant, manage taxes, and maximise your take-home pay.
Is a limited company always the best option for tax efficiency?
Not always. If you’re on short-term contracts or earning under a certain threshold, an umbrella company or sole trader setup might be simpler and more suitable. The best option depends on your income level, contract length, IR35 status, and appetite for admin.
Important:
Please note: Any rates and thresholds mentioned in this article are correct at the time of publishing and may be subject to change.
When choosing an accountant, look for one with proven experience and expertise in the contracting sector, particularly around areas like IR35, limited company tax matters and off-payroll working. Formal qualifications are important, but relevant hands-on knowledge matters just as much — especially in a complex and fast-changing landscape like this.
