Limited Company Tax

Freelance contractors wishing to work through their own Limited Company, need to be aware of limited company tax and its effect of the tax position of a contractor who is also a shareholder of a Limited Company.

In the UK Limited Companies are taxed in a completely different way to employed or self employed freelance contractors. Limited company tax is known as Corporation Tax (CT), which is a tax on the profits that the company makes in its trading year or accounting period.

The profits of a company are the funds remaining after the deduction of all allowable expenses, such as the costs of employee salaries and legitimate business expenses. These remaining profits are identified in the company’s annual accounts, and declared to HM Revenue & Customs in the Company Tax Return - .CT600

There are two main rates of CT in the UK, currently 21%, reducing to 20% in April 2011, on profits below £300,000, with profits of £300,000 and over being taxed at 28%, reducing to 27% in April 2011, with a further 1% cut in each of the following three years, bring the higher CT rate down to 24% in April 2014.

Once CT has been accounted for, the remaining funds are available for distribution to the shareholding freelance contractor of the company as ‘Dividends’.

To compensate for the fact that CT has already been paid on company profits, all dividends come with a 10% tax credit. Therefore the ‘gross’ dividend received for use in calculating the contractor’s gross income, prior to accounting for taxation, should be calculated using the following formula;

Gross Dividend Received / 9 * 10 - e.g. £1000 / 9 * 10 = £1111.11

Dividends received from a Limited Company attract Dividend Tax (DT) which is an additional personal tax that is declared on a contractor’s year end Self-Assessment Tax Return. The rates payable are linked to the contractor’s declared total annual income as with PAYE salaries and self employment income.

There are currently three rates of DT; 10% payable on dividend income at or below the basic rate tax limit, 32.5% payable on dividend income at or below the higher rate tax limit, currently £150,000 (2010/11) and 42.5% payable on dividend income above this higher rate tax limit.

To calculate the amount of DT payable;

Gross dividend received below the basic rate tax limit * 0 (10% - 10% Tax Credit)
Gross dividend received below the higher rate tax limit * 22.5% (32.5% - 10% Tax Credit)
Gross dividend received above the higher rate tax limit * 32.5% (42.5% - 10% Tax Credit)

Although the above calculations should be undertaken to achieve accuracy in calculating DT, the following rates will give a clear indication of the taxes due on net dividends received;

Net dividend received below the basic rate tax limit * 0%
Gross dividend received below the higher rate tax limit * 25%
Gross dividend received above the higher rate tax limit * 36.1%

You can read more about running your own Limited Company in our articles section, then, take a look at our service provider directories, to find a range of service providers who can help you get the most out of your contracting.