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The recent budget has a significant impact on contractors. Do these budget changes mean it is now better for a contractor to go limited or use an umbrella company?
In a previous post I highlighted the budget changes affecting contractors. You can find this here.
The main budget change affecting contractors is the replacement of dividend tax credits with a £5k tax-free dividend allowance. This is a blow for contractors using a limited company.
At the moment, if you have basic rate earnings then the 10% dividend tax is cancelled out by the 10% dividend tax credit so there is no personal tax to pay. However, the changes will mean that while the dividend tax drops from 10% to 7.5%, the 10% dividend tax credit has been scrapped and replaced by a £5k allowance. Whereas currently there is no tax to pay on basic rate dividends, there will soon be 7.5% to pay on all dividends over £5k per tax year. For contractors taking the maximum basic rate earnings of £43k next year this will mean around an extra £2k in dividend tax. This is a big change for contractors who currently pay nothing or very little through personal tax returns.
So, looking ahead to next year when these changes kick in will it be best to use an umbrella company or operate through your own limited company?
The most common earnings mix taken by contractors using a limited company is the combination of a salary and dividends that pushes them to the limit of the basic rate. Using this earnings level of £43,000, let's compare take home pay for contractors using a limited company with an umbrella company:
Tax saving from using a limited company rather than an umbrella company = £1,460 pa
This just looks purely at the tax on earnings and even on that basis there is still a significant benefit of going limited. I will go on to look at other significant factors in favour of contracting through a limited company.
Flat Rate VAT Scheme
The flat rate VAT scheme is open to contractors who use a limited company but not contractors using an umbrella company.
Through this scheme, a contractor invoicing £43,000 could add 20% VAT to all invoices and so earn an additional £8,600pa. Of this £8,600, just £6,192 would need to be paid as flat rate VAT (assuming the usual contractor flat rate of 12%) and this would leave a gain of £2,408 in the company. Corporation Tax of £482 would be due on this leaving a whopping net gain of £1,926 pa through using this scheme.
Flat rate VAT saving from using a limited company rather than an umbrella company = £1,926 pa
(If you are an existing client of CEJ Contractor Accountants and would like to know more about how you could benefit from the flat rate VAT scheme then please follow this link.)
So, despite the budget changes it will still be much better for contractors to go limited than use an umbrella company. For a contractor currently invoicing £43,000 and using the flat rate VAT scheme, the overall benefit of going limited is a massive £3,386 pa.
If you would like to discuss any of the above then please leave your comments below or get in touch.
CEJ Contractor Accountants offer the most complete, hassle-free services for contractors who would like to go limited from just £59+VAT per month. Click here for more details...