UK Contractor Tax

If you are a contractor in the UK there are 4 main options for getting paid - Umbrella Company, Limited Company, PAYE, Self Employed. Each has their own tax requirements and the net retention can vary dramatically.

With Pay-As-You-Earn (PAYE) you are effectively paying the same rate of tax as a permanent employee despite not enjoying the same benefits in terms of annual leave, holiday pay and pension contribution. Whilst it is very easy to get paid this way, the high rates of tax make it unappealing. This is especially true because the highest tax rate is 50% and under the PAYE scheme each paycheque is processed as though you earn the same amount every time. So if you only worked 9 months of the year on a lucrative contract rate - lets say £750 per day - you would be taxed as though you had worked all year at the same rate until you had filed your tax return and claimed a rebate. This is doubly frustrating for a contractor.

Running your own Limited Company can reduce your tax burden by a startling amount because your primary tax burden falls to corporation tax at 20% plus dividend tax. If your contract is assessed to fall under IR-35 you may be liable to pay similar taxes to a PAYE employee, so you need to be careful prior to setting up in this way. A good tax advisor will be able to review your contract and advise whether it is ok to proceed. You can get up to 70% net retention using a Limited Company.

Self Employed allows slightly more flexibility in terms of when you pay your taxes, especially for the first 18 months until you start paying regular tax installments. It allows more expense offsets than PAYE but isn't quite as powerful as a Limited Company in terms of protecting your assets and reducing your tax burden.

Umbrella Companies are setup specifically to pay contractors in the most tax efficient way that the law allows. Because Umbrella Companies will have thousands of contractors being paid through them they can afford to get the best legal and tax advice to setup a scheme which will get approval from the HMRC. They can also review your contract to ensure that it is IR-35 compliant. With an umbrella company you can net upwards of 80% of your gross billing.

You can compare your net earnings using our UK Contractor Calculator.