One of the most challenging things about becoming an independent contractor is understanding what taxes need to be paid and navigating when to pay them.
The UK has one of the highest numbers of independent contractors globally, with over two million people identifying themselves as self-employed independent contractors. Contractors are responsible for paying taxes on company profits and personal income. In this guide, we will cover the following:
- Notifying HMRC
- How to register your business
- Types of taxes you may need to pay
- Keeping track of your taxes and accounting
- How to submit your taxes
- How to save time on your tax return
The first step is notifying HM Revenue and Customs about your business. How you register your business will directly impact how much you pay in tax and the liability your personal finances will face. We cover common ways to register your business below.
If you work under an umbrella company, your tax is handled automatically through the PAYE (pay as you earn) system. National insurance and workplace pension contributions will also be handled accordingly.
How to register your business
Registering as a sole trader
This is a common method that lots of self-employed contractors choose to use. Being a sole trader means you run your business as an individual. This can give you lots of flexibility over your schedule and workload, but it also means your business assets and liabilities aren’t differentiated from your personal ones. Being a sole trader is ideal for anyone who wants to start out simple before expanding with additional products and services. Use our guide to help you register as a sole trader.
Setting up a limited company
Setting up a limited company is a popular route for contractors with a long business history and larger client base. However, it comes with more admin obligations for your financial reporting which can be needlessly burdensome for some entrepreneurs, depending on their business’ size. Find out more in our article How to register a limited company.
In the next sections, we’ll look at some of the taxes you will have to pay as a limited company compared to the tax rates for sole traders and how to pay each of them.
Types of taxes you may need to pay
- Income Tax: UK citizens are entitled to a personal allowance of £12,570 that’s tax-free. Once you earn beyond this, you will be subject to tax rates according to how much you earn. You will need to complete a Self Assessment Tax Return and pay any taxes owed on any income that you receive by 31 January after each tax year. Failure to meet the deadline will result in a fine.
- Corporation tax: Limited companies have to pay corporation tax on any profit they make directly from their business or from the sale of any assets they have. To pay this tax, you will need to file a Corporation Tax Return (CT6000) and pay any taxes owed nine months after the accounting period of the previous financial year.
- National Insurance: Self-employed individuals, like sole traders, pay Class 2 and 4 national insurance but at specific rates depending on their profits. If you’re a limited company director, you have different rules because you’re classed as an employee for tax purposes. Find out more here.
- Value Added Tax (VAT): VAT is a tax that businesses (companies and sole traders) charge customers and pay to HMRC. However, businesses are only obligated to charge VAT if they have an annual turnover of £85,000 or above. Learn more about VAT for small businesses, including its rates and future in our guide.
- Dividend Tax: One of the most efficient ways to make the most of your income is to draw your money from your dividends, i.e., shares in your company. However, this method of income filing is only available to company directors. Learn more about dividend allowances and tax rates here.
- Capital gains tax: This tax affects sole traders and works similar to corporation tax. Capital gains tax is applied to the profit you make on the sale of business assets and is relative to your personal income. There are some exceptions, like cars and goods up to £6,000, and allowances depending on who you sell the assets to. Therefore you’ll need to be familiar with when you need to pay it.
Keeping track of your taxes and accounting
How do you know which taxes you need to pay and how much?
Across your trading, you’ll need to keep track of your business’ income and expenditure. The exact extent of your admin will depend on whether you’ve chosen to operate as a sole trader or as a limited company. In general, you’ll need to keep a record of receipts and invoices you send to clients and those your business receives. You may also need to keep records of your personal income, assets your business has and the equity and structure of your company.
How to submit tax
Independent contractors can pay their income taxes through HMRC’s Self Assessment system. Self-employed business owners earning over £10,000 will need to sign up for HMRC’s Making Tax Digital initiative for their income taxes by 6 April 2023 and follow the rules for future returns.
Similar schemes for VAT returns and corporation taxes are either currently live or are planned in the next few years. Therefore, businesses will have to find approved software solutions like Countingup for their future accounting and tax payments.
Save time on tax return admin
If you’re new to independent contracting work or running a limited company, figuring out your tax obligations can be confusing. Without a complete understanding of UK tax rates and where your income falls in relation to them, you could end up paying more than you need to, or with fines on top of what you owe.
The Countingup app is saving thousands of contractors across the UK hours of stressful admin. Countingup is the business current account and accounting software in one app. It automates time consuming financial admin so that you can focus on running your business. With instant invoicing, automatic expense categorisation and cash flow insights, you can confidently keep on top of your business finances everyday.
You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple and straightforward!
Get the Countingup app to apply for your business current account in minutes. All you need is proof of ID and a selfie. Find out more here.