Limited Company Contractor Tax Case Study 2022-23

In this article we work through a hypothetical case study of a contractor / freelancer working through their own limited company to explain how the tax works and some options for tax planning.

The tax rates are based on the 2022-23 tax year.

Gerry provides IT consulting services and for the 2022-23 tax year has accepted an outside of IR35 contract on a day rate of £500 per day and he has setup a limited company to work through going forwards.

Key assumptions made:

  • Gerry’s only personal income for 22-23 are his salary and dividends from his company
  • He doesn’t have a student loan balance
  • He doesn’t receive child benefit
  • He is a UK resident taxpayer
  • He is the only director and shareholder of his company
  • The contract is outside of IR35
  • He works 220 days during the year – at a day rate of £500 this is £110,000 of income (excluding VAT)

When it comes to salary, we have assumed Gerry is on an annual salary of £9,100 which protects his national insurance position and is at a tax efficient level – we have more information on this here:

Optimum Director Salary and Dividends 2022/23

With regards to Gerry’s business costs, we have assumed them to be as below:

  • Software and subscriptions £3,000
  • Travel and subsistence £3,000
  • Accounting fees £2,000
  • Working from home claim £2,000
  • Other sundry allowable costs £1,000

Based on the above information the profit and loss account and corporation tax calculation of Gerry’s company is shown below – all income and costs are excluding VAT:

 

Limited Company Contractor Tax Case Study 2022-23

 

We can see from the calculations above that Gerry’s company will have corporation tax to pay for the year of £17,081 and the post-tax profits generated are £72,819.

The £72,819 of post-tax profits is the maximum amount of dividends that can be paid out to Gerry during the year (if Gerry had unused retained profits from previous years these can also be used to pay dividends but as this is a newly setup company there are no brought forward retained profits to factor in).

If Gerry decided to extract all of these profits as dividends during the tax year his total salary and dividend income would be £81,919 which would be significantly above the higher tax band of £50,270 and would result in large personal tax charge on his dividends.

For 22-23 the personal tax on dividends is calculated as below:

The first £2,000 of an individual’s dividend income is tax free due to the dividend allowance

Over and above this £2,000 the dividend income is taxed as follows:

  • If you have any un-used personal allowance (£12,570) then that element is tax free
  • Any dividends in the basic tax band (up to £50,270) attract a tax charge of 8.75%
  • Dividends above the basic tax band (over £50,270) are charged at 33.75%
  • Any dividends in the upper tax band (£150,000+) are taxed at 39.35%

Therefore, if Gerry extracted the maximum amount of dividends from his company his personal tax calculation would be as below:

tax calculation 22-23

The total personal tax per the above comes to £13,805.

 

Limited company tax planning – flexibility of dividends

One of the advantages of trading through a limited company is that you have flexibility with the value and timing of when you pay dividends.

If Gerry didn’t need to pay himself all of the retained profits as dividends and was able to limit his dividends to keep his personal income below the higher tax band, he could reduce his personal tax substantially and it would now look like this:

tax calc 22-23

 

The personal tax due in the above example is significantly lower – but £31,649 less dividends have been extracted which leaves this amount of retained profit in the business to carry forward to future years, see below:

 

corporation tax dividends 22-23

 

Limited company tax planning – retained profit

The next thing to consider is what to do with that spare retained profit.

One benefit of building up profits in a business is that it gives you some financial security – over £30,000 of retained profit should be enough to pay quite a few months of salary, dividends and business costs which could be very useful if there is a gap between working on contracts for example.

Something else to consider is if you have a spouse who is a basic rate taxpayer then you could think about them becoming involved in your business in order to pay them salary / dividends to make use of some of their un-used basic tax band. This can be quite complicated so we’d recommend discussing your specific circumstances with an accountant before going ahead with this plan.

Another tax planning consideration which can be very tax efficient is having your company make pension contributions into your pension scheme, we have an article on this topic here:

Company Pension Contributions for Directors

There are various rules and limits to be aware of with pension contributions so we would encourage you to discuss your specific circumstances with a pension advisor.

Going back to our example, if Gerry now decides to make £25,000 of company pension contributions in the year the figures now look like the below:

company pension contributions 22-23

 

The corporation tax has been reduced by £4,750 (19% x £25,000) and it still leaves over £11,000 of retained profit at the end of the year to carry forward to future years.

 

This article covers just some of the typical tax planning opportunities that working through your own limited company can offer you – however we would always recommend discussing your specific circumstances with an accountant.

 

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