Should limited company contractors take a salary?

Both existing contractors and those looking to work on a freelance basis for the first time are increasingly investigating whether setting up a limited company and operating through this would be the most beneficial process for them.

However, it is important to remember that this option will not be open to you if HM Revenue and Customs (HMRC) decides that you fall inside the IR35 legislation.

This ruling was designed to prevent the situation where salaried employees were being listed as company directors and therefore paying minimal tax and National Insurance (NI).

As a result, HMRC now decide on a case-by-case basis whether you are inside or outside of the legislation and this revolves around its definition of ‘self-employed’ – something which isn’t readily available.

Therefore, it is difficult to know where you stand, broadly speaking, if you decide when, where and how you work, you are likely to be considered to be outside of IR35 and will be free to operate as a limited company contractor. Otherwise, you are likely to fall inside the legislation and should then consider utilising the services of an umbrella company as an alternative.

As the director of a limited company, you can legally divide your earnings as a contractor between a salary and dividend payments. Although the salary will be taxed and subject to deductions just like a regular full-time employee, you will pay a lower level of tax on dividends and will make no NI contributions on these amounts.

Although there is no legal requirement to take any sort of salary at all from your company, choosing not to is likely to raise the suspicions of HMRC and you could well find yourself under investigation.

Dominic Haslam, a senior manager in the taxation division of Deloitte, told Contractor Calculator: “It’s not so much a question of whether you make the salary very high, or very low, as it is whether or not you are securely outside IR35.

“The result is that, if you are outside IR35, then you can take as much or as little in salary as you want, but you should review the matter with a professional.”

For this purpose, you should look to utilise an accountancy services provider such as PayStream.

The vast majority of contractors ensure that they at least take the national minimum wage as a salary, as while this will minimise your tax burden, it does mean that you also make some contribution to NI.

Indeed, it is also possible to list a spouse or family member as an employee of your limited company, which some contractors like to do to ensure their NI contribution is also covered. If you are planning to do this, make sure you’re aware of the settlements legislation – something else that an expert will be able to help you with.

However, the benefits of limited company contracting are not limited to paying yourself a minimal salary and an accountancy services provider will be able to advise you if it will be more beneficial for you to withdraw a higher salary.

This enables a greater degree of flexibility in pension scheme payments, as tax is already paid on the salary and so the money can be added to tax-free pension schemes easily.