How contractors can cut their corporation tax bill

With the end of the 2012-13 tax year fast-approaching, the ContractorUK Money Club explores how limited company contractors can reduce a large tax bill using a company pension with IFA ContractorMoney.

If you have built up a pot of retained profits in your limited company, then you could invest them directly into a pension and avoid a hefty corporation tax bill. While this will mean delaying getting your hands on the cash until you reach age 55, it does represent a very tax-efficient method of transferring funds from company to personal hands. At 55, you can choose to release up to 25% of your pension as a tax-free lump sum with the remainder left to grow or used to provide an income.

As long as your day-to-day expenses are covered and you have taken any salary or dividends that you require, you should be able to invest as much of your remaining income and current year profits into a pension as you would like because there is no relationship between salary and the size of a company contribution. As funds are transferred directly, there is no personal income tax or national insurance deduction and you also save on the corporation tax that you would otherwise have paid on this year’s profits.

A company contribution into a pension fund can be made directly from retained profits held in a contractor's limited company account. In addition, current year's profits can be transferred and these are no longer liable for corporation tax. This enables the company's owner to reduce their corporation tax bill considerably, as they will only be charged tax at 20% on profits left in the company at the end of the trading year.

Alternatively if you would prefer to make a personal contribution then you can take a larger than usual dividend and invest personally to save on income tax. It is worth remembering, however, that personal contributions are limited to 100% of salary (which is probably already low) whereas company contributions are unlimited.

Don’t forget your ISA allowance before April 5th

You may want to use up your remaining ISA allowance before the tax year ends on April 5th 2013 as you can currently invest up to £11,280 - and up to £5,640 of that in cash. Unfortunately the tax relief on ISAs is given on growth and not on contributions, so it won’t make any difference to your tax bill next January but you can access the funds at any time rather than waiting until you are 55. ISA contributions must be made from personal income so you need to bear in mind that you will have already paid income tax.

Further tax savings available with Keyman insurance

If you would prefer to avoid as much of these personal taxes as possible then another popular tax saving option for limited company contractors is to transfer your life insurance costs, currently paid from your post-tax income, into a company funded Keyman plan.

This new Keyman insurance is written with a specific trust that not only avoids any benefit in kind on the premiums but also ensures that benefits are paid directly to your loved ones rather than in to your company account, avoiding any corporation tax bills when and if it is paid out. This innovative insurance offers all the peace-of-mind of a life insurance policy with the added bonus of tax relief on the premiums and is proving very popular with contractors.

Tax saving even if you do nothing

Even if as a contractor you don’t opt for any of these tax-saving routes, you still should be better off by this time next month. That’s because, as stated in our financial review of Autumn Statement 2012 for ContractorUK, individuals will receive the first £9,440 of their income free of tax – up by £1,335 – from April 2013. This means that contractors can imminently earn up to this amount without paying a penny of it to the taxman and, fortunately for them, higher rate taxpayers will benefit from this increase too, unlike in previous years.

Wednesday 27th Feb 2013