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Contracting through your limited company

Operating a limited company can be relatively simple if you are contracting.  However, there are still certain things you should consider or be aware of.

Separate legal entity

A limited company is a separate legal "person" whom they can borrow, lend and pay taxes as any other normal person.  As a director (and shareholder) your responsibility (and financial exposure) is limited - usually to the amount of share capital created through the company.  However, this "limited" restriction is only respected under normal legal trading activity.  Therefore, if you undertake illegal activities or do not run the company responsibly you will be held directly responsible for the actions of the company.

Bank Account

As a legal person you will be required to set up a separate business account for the limited company and operate this separately from your personal expenditure.  All income should be directly paid into this account and, where possible, all expenditure should be paid from this account.

Any payments made to you should be using this account also.

VAT

You should next decide whether you want the company to be registered for VAT (see VAT schemes).  If you are just starting your business you do not need to register for VAT until your turnover exceeds £77,000 in the previous 12 months.  However, you can voluntarily apply to become VAT registered - and sometimes this can be beneficial.

Once the company is VAT registered you must charge VAT (at 20%) on any invoice you send to your client.  Please be aware, this money is collected on behalf of HMRC and thus it is not your money.

You can opt to calculate VAT using a number of schemes but the flat rate scheme is one of choice for contractors.  With this scheme, you would charge your client 20% but pay HMRC a lower percentage (13-15%) from your total gross income.

For example, if you charge your client £1,000 + VAT (£1,200) you would pay HMRC (based upon 13.5%) £162.  This means you are actually slightly better off, by some £38!

Expenses

Similar to being employed, you can claim back expenses incurred personally on behalf of the company.  Any expenses paid personally can be reimbursed back from the company tax free.  All receipts and mileage logs must be kept however.

If you are re-charging expenses to your client, please ensure you add VAT on to any expenses you are claiming back.

Bookkeeping

Bookkeeping is an essential part of running a limited company as each year you are required to complete a set of accounts, a tax return and declare the amount of tax liability your company is liable to pay.  If you have not kept a proper record you may well be underpaying or overpaying the amount of tax due.

In order to keep a record of income and expenditure it is recommended you keep some sort of bookkeeping file.  The simple approach is a spread sheet detailing all income and all expenditure (split between expenses and direct payments).  Alternatively, use an accounting package to enter income and expenditure onto and this will also help automate many tasks.

Wages and Dividends

When you take money from the company you must ensure that it has been taken legally and using the relavant forms.  It is usually advisable to take a salary from the company first and top this up with dividends after.  Dividends are distributions of profits after tax and thus it is essential you leave enough in the company to pay any taxes that are due.

Other forms and requirements

There are certain other tasks to complete during the course of the year that a company must undertake.  Some of these tasks are related to Companies House (Annual Return) and some relate to HMRC (PAYE).

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