Mitigating the new 26.5% marginal corporate tax rate on your contractor profits

As a limited company contractor you will be very aware that from April 6th 2023, corporation tax is rising to 25% when profits exceed £250,000, and if profits are between £50,000 and £250,000, the marginal rate is 26.5%.

So you -- and us as your accountants -- need to be mindful of this new marginal rate, especially when deciding about extracting profits to live on, writes chartered accountant Jeffrey Lermer, founder of JLA Accountants.

There will be lots of options, and these need to be properly considered, ideally now or any other time well before April 6th.

Contractor case study: Taking £10k out of your limited company

So you want to extract £10,000 net from your limited company, let’s look at the comparable cost for your business. And for simplicity’s sake, let’s say you are a basic rate taxpayer. 

Salary

As you will be paying personal income tax at 20%, and employee national insurance at 12%, you will need a salary of £14,705 -- but that costs an additional 13.8% employer national insurance. So the total cost to your company is £16,735.

Dividends

As you will be paying income tax at 8.75%, you will need a dividend of £10,959 but that number is after corporation tax, and if that is 25%, the cost to your business is £14,612. If corporation tax is at the 26.5% marginal rate, suddenly this cost rises to £14,910! As I've said previously, dividends are better than salary, but the difference is getting far more marginal.

Rent or interest

If you are able to charge your company rent or interest, these are very worthwhile options to explore. The gross cost to the company is £12,500, as you pay personal income tax at 20%, giving you net income of £10,000.

So even on £10,000 net, the variations in cost are between £12,500 and £16,735, or over £4,200.

In short...

The key to tax planning here, may be trying to keep your profits at £50,000, as corporation tax will seem refreshingly efficient at just 19%.

But what about expenses?

By all means contractors, go ahead and claim your Christmas party; a director's trivial benefits (that's often 6 x £50 Amazon vouchers) and claim working from home (not exclusively in a room, so capital gains tax is not affected). Oh, and definitely maximise pension contributions.

Finally, cash-in when you retire

Assuming you will be a basic rate taxpayer in retirement, pay into your pension £40,000 (from your company), saving £10,600 in corporation tax as a result. Then on retirement, get £10,000 tax-free and pay 20% personal income tax on the remaining £30,000 – that’s just £6,000 to HMRC.

So not bad. It costs you only £29,400 to put £34,000 in your pocket!

Ending with a question (but also an answer)

Very finally, what is tax planning? To shrewd contractors, it may sound like an easy-to-answer question.

Well, one aspect of tax planning which the above hopefully makes clear is that it’s about planning your remuneration. But that’s not only what tax planning is. It’s about planning your life. And structuring your life in a tax-efficient way. Yet nowadays perhaps even that isn’t enough. Increasingly, I’m of the view that tax planning is about planning your working life and your life after work, both tax-efficiently. And the job of us tax planners is to understand what you want, particularly with this unwanted marginal rate effective just eight weeks from today.