First timer's guide to Limited Company contracting

Once you have your first contract in place, and you are ready to start work as a freelance contractor. It’s time to setup your own contractor Limited Company.

Contracting through your own contractor Limited Company is not difficult for first time contractors. The vast majority of IT contractors work through their own Limited Company. For most UK first time contractors, this is the most tax efficient way of contracting. It is quick to set up a new Limited Company.

What is a contractor Limited company?

The term 'limited' means that the company's finances are distinct from the personal finances of the freelance contractor. Private Limited Companies are the most typical setup for IT Contractors. This type of contractor limited company cannot offer shares to the general public, but may have any number of shareholders - typically one each for a husband and wife.

How do I setup a contractor Ltd company?

A contractor limited company has to be registered with Companies House and has various legalities. The steps in setting up your contractor limited company, which your accountant should be expected to handle for you, are detailed below.

Naming your contractor limited company

You will need first to decide on a name for your contractor limited company. For first time contractors, this can be the most difficult part!
You do not have to use the term ‘IT contractor’, ‘contracting’ or ‘freelance’ in your company name as the name does not have to be tied to your current work. Your contracting work may expand or change over time. Check if your preferred limited company name is available at www.companieshouse.co.uk. You may also want a corresponding domain name for your contractor company.

Contractor company directors

You will need to appoint at least one company director for your ltd company. Usually this is the freelance contractor. There are legal responsibilities in becoming a director of a limited company which first time contractors should be aware of, such as paying taxes on time. Each limited company must have a director to make management decisions.

Company secretary

A contractor Limited Company no longer needs a company secretary (Companies Act 2006).

Bank account for your contractor company

The limited company will require a bank account. You cannot use your own personal bank account for receiving revenues earned by your company from contracting. Your contractor Limited Company will invoice your agency/client for work performed, not you personally. Contractor accountants will be able to suggest the best options for your contractor bank account. Not all high street banks are suitable for the requirements of a Limited Company contractor and freelancers should take recommendations. We recommend Cater Allen Private Bank.

Contractor Ltd company shareholding

You will then need to decide on shareholding in your new contractor company. You may choose to allocate 100% of the shares to yourself, or split the shares. Shareholders in limited liability companies are not responsible for any contractor company debts beyond the value of the shares. Your contractor accountant will give you advice on “Income splitting' - dividing up dividend income - dependent on contractors’ own personal circumstances.

There are different types of shares, for example preference shares, linked to specific rules related to the company's operations. You will need to get professional advice from your contractor accountant if you are considering this structure for your contractor limited company, but generally ordinary shares will suffice.

Memorandum of Association

A Memorandum of Association is then filed with Companies House. This is a document that tells everyone why you've set up the contractor company, and how you plan to run it. The Articles of Association outline directors' powers, shareholder rights, etc, in a standard format.

VAT Registration for contractor companies

Finally in setting up your contractor limited company, you may register for VAT. Registering for VAT can be done online at the HMRC website and handling VAT online is easier than on paper. VAT registration may take a little time to come through, but don't worry as you can back-bill your clients for it. A professional contractor accountant will handle your VAT for you to avoid costly mistakes. And if you register for the Flat Rate Scheme VAT processing every quarter is a piece of cake and saves you tax.

Starting Contracting via a limited company

Contracting using a Ltd Company has advantages for the UK contractor. As a limited liability company director, you have no personal financial liability if the company fails. You, the freelance contractor, and the contractor company are two distinct entities.

As director of this separate legal entity, you will need to comply with various tasks each year. For example, you will need to submit an Annual Return (Form AR01) each year, keep Companies House informed with any changes in the way your contractor company is run, and ensure that your contractor ltd company accounts are submitted accurately and on time.

The majority of UK contractors will use a qualified contractor accountant to take care of all accountancy requirements - including tax, VAT, payroll, and correspondence with HMRC. A contractor accountant will be able to take away the worries of running a Ltd company for first time contractors.

Tax considerations

A few of the tax considerations for first time contractors:

• If your contract falls outside the IR35 rules, you will be subject to normal corporation and personal tax rules.
• Your contractor Ltd company will be subjected to corporation tax on your profits.
• Depending on your salary, your contractor accountant will deduct any PAYE and National Insurance liabilities at source. You will draw your net salary at agreed intervals.
• You will withdraw the remainder of your income from your contractor ltd company in the form of company dividends, which is the most tax efficient way of withdrawing funds from your company.
• You may pay further personal tax on your dividend and other income via the self assessment system each year, if you are a higher rate tax payer.
• Even if your contract does not fall outside IR35, you can benefit from the Flat Rate VAT scheme and the 5% expense allowance.

Benefits of Contracting through your own limited company for first time contractors

• Generally, a limited company for a freelance contractor, will maximise tax advantages available as dividends do not attract national insurance deductions.
• Contractors can claim a wide range of expenses – business travel, internet, contractor accountancy fees, IT equipment, software, phone calls, etc.
• Contractors have access to the Flat Rate VAT scheme.
• Your money is completely under your own control with your own ltd company.
• A limited liability company structure provides protection to the UK contractor.
• It is not difficult for most contractors to run their own contractor limited company with the assistance of an experienced contractor accountant.