Understanding accounting as a consultant can be tricky. Read on for some useful information that can help you avoid mistakes.
To show you how you can do better accounting as a consultant, this article will cover:
- A brief overview of what IR35 is
- The difference between a contractor, a consultant, and a subcontractor
- The difference between a sole trader and a limited company
- Accounting software for consulting businesses
What is IR35?
IR35 is the part of UK tax law that attempts to stop consultants, contractors and freelancers from pretending to be employees. This is a common issue that has gotten worse over time for HMRC.
On the other side, it’s supposed to stop companies from getting the benefits of a full-time employee without paying national insurance contributions and benefits.
For example, Sam, a graphic designer, operates as a limited company or sole trader with a contract to do design work for Tina, a florist.
Every month Sam invoices Tina and is paid into her business bank account. Sam’s contract has no defined end date, but there is a verbal agreement between the two parties that in order for both sides to save money, Tina will not be taken on as an employee.
What does ‘inside’ and ‘outside’ IR35 mean?
Inside IR35 means that HMRC sees you as an employee and expects the corresponding tax contributions from you in the form of income tax and national insurance.
Outside IR35 means you are self-employed, so you can enjoy better tax efficiency than if you were employed.
Here are some tips that can help you to remain a consultant/freelancer and not have potential confusion on whether you’re inside or outside IR35:
- Ensure that you have a clear agreement in place that reflects the actual relationship between you and your client. A verbal agreement isn’t enough if legal proceedings happen.
- Ensure that you invoice the client for services and are not paid through their payroll.
- Make sure you have evidence of negotiating your rate.
- Avoid using any of the client’s resources to work. Use your own equipment and, if possible, your own premises to carry out the work.
- Try to keep control over your working patterns.
- Don’t do work for one client for an indefinite continuous period. Make you take breaks so that you’re able to work for other clients.
- Don’t put your details into the company directory, e.g. company email, business cards etc.
- Don’t collect any payment if you are sick or on holiday. HMRC could class you as an employee as this is only reserved for those on PAYE.
- Even if you believe everything is going well, regularly review the terms of your agreement and ensure it matches with what is happening in practice.
IR35 is one of the most contested parts of the tax law, and there are times when HMRC themselves are unsure just how the law they created works in practice. We recommend doing extensive research and/or hiring a professional who is familiar with it before making any decisions.
What is a contractor?
A contractor is a person or a company seeking to do business on a contract basis, meaning they carry out a specific set of tasks for a pre-agreed fee. It’s common for contractors to be industry experts in fields like:
- IT maintenance and support
- Building services and construction
- Gardening and landscaping
- Plumbing and electrical services
- Carpentry and joinery
- Painting and decorating
- Cleaning services
- Property maintenance
- Security Services
- Independent audit services
They are usually hired for a fixed time and can be appealing to businesses that need help but still want to maintain flexibility, e.g. not have to put them on their payroll.
Contractors usually aren’t offered any additional benefits, so they can command very high rates for their services. There is usually an agreement between the two parties for the necessary work to be carried out within a set time period.
This type of work is generally done on site either at a residential or commercial location.
What is a subcontractor?
A subcontractor is a business or individual that a contractor hires to help complete a project. For example, a construction company can be hired as a contractor for a job if they hire a painter to paint a house as a part of that job, that painter is a subcontractor.
What is a freelancer?
A freelancer can refer to a wide range of people who offer their services to companies on a long or short term basis. They charge a pre-agreed hourly rate or fixed fee.
You may come across the term ‘day rate’ for some freelancers, which refers to the amount they charge per day. Freelancers don’t always carry out work at client premises as sometimes they will often have their own, in the form of a home office or co-working space.
They can be either a sole trade or be a director of their own limited company.
Freelancers tend to be in the media, creatives and tech industries, with roles such as:
- Graphic designers
- Website designers and developers
- Actors and musicians
- Filmmakers and videographers
- Marketing coordinators
- Social media experts
Often some of these roles can overlap. For example, a marketing coordinator can also specialise in SEO.
What is a sole trader?
A sole trader is a self-employed person who owns and runs their own business. Sole traders are directly tied to their business.
This is a great way of setting yourself up if you’re just starting and don’t yet have a high volume of work. You will have to submit a Self Assessment to HMRC, pay income tax and national insurance contributions yourself.
Benefits of being a sole trader
- As a sole trader, you’re in full control of your business. There is no scope for other shareholders.
- Being the sole decision-maker, you have much more flexibility in how you run your business.
- Normally sole traders are closer to customers due to the often smaller size of the business.
- You won’t need to tell HMRC that you’re self-employed or register a company with Companies House. This makes it a lot easier to set up, with lower costs.
- The accounting process is much simpler for sole traders than for limited companies.
- You’ll still need to record invoices and expenses and submit a personal Self Assessment Tax Return.
- As a sole trader, your financial information is kept private, making it harder for your competitors to see how you’re doing.
- It’s a good way to see if owning a business is for yo
Downsides to being a sole trader
- All liabilities and debts of the business are your responsibility.
- People you want to sell to may see you as less attractive or skilled than someone who has a limited company.
- Some customers and clients that only want to work with companies may refuse to hire you.
- A sole trader can’t draw dividends from their company, which are taxed at a lower rate. Anything that a sole trader earns is subject to income tax in the financial year they’ve been made.
What is a limited company?
A limited company is a business that is legally separate from its owner. In the case that we mentioned before, the plumber wouldn’t be personally liable for any damage if they were doing the work through their limited company. They would also not have to
A limited company becomes more useful when you have a higher volume of work and are making more significant amounts of money. With this setup you can begin to lower your tax obligations.
Benefits of owning a limited company
- You’ll have less personal liability.If your company gets into financial difficulties your personal assets will be safe. Any debts or legal claims are the responsibility of the business, not you.
- Having a limited company is often a sign of commitment and expertise, which can make it easier to attract clients and investors, expand into different markets, and create a trusted brand identity.
- It’s more tax-efficient. The current UK Corporation Tax rate is 19%, whereas sole traders can pay up to 45% Income Tax.
Downsides to owning a limited company
- The financial admin of a limited company is much more complex than being a sole trader.
- Your company accounts will be available for anyone to see online, which you may not feel comfortable with.
- Withdrawing money from a limited company can be a complicated process. Also, you’ll have to keep minutes of all meetings between shareholders and directors.
Manage your accounting easily and efficiently with Countingup
How can Countingup help you as a consultant, contractor or freelancer?
Countingup is a business current account that comes with free built-in accounting software that automates the time-consuming aspects of bookkeeping and taxes. Instant invoicing, automatic expense categorisation and cash flow insights mean that you can confidently keep on top of your business finances every day.
You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags, or inaccuracies. It is seamless, simple, and straightforward!
Download the Countingup app to apply for your business current account in minutes. All you need is proof of ID and a photograph of yourself. Download the app here.