A Guide to Contractor Tax Legislation and Penalties

There are many attractive things about becoming a contractor, but even as contractor accountants we can’t honestly claim that contractor tax legislation is one of them. It’s true that as a contractor your gross earnings will typically be higher than those of a regular employee – enough so that you will still find contracting financially worthwhile after tax – but you will need to tackle your taxes in the best way possible in order to do so. Many different systems have been designed or adapted to help contractors manage their taxes and be paid in a timely manner, from umbrella companies to professional employer organisation (PEO) solutions to incorporating as a limited company. But why are they so popular?

VAT Registration

The ability to claim Value Added Tax (VAT) back on your invoices (where your direct client is VAT registered) can be a huge benefit for contractor limited companies. And, in fact, it may be compulsory to register for VAT – for example, if your total taxable turnover in a 12-month period goes over £90,000. VAT claims should be scrupulously correct. In cases where a VAT inspection finds it has been claimed back for unnecessary reasons, HMRC can recall up to 6 years’ previously claimed VAT – a significant amount of money to have to find at once. As with all taxes, VAT must be paid promptly. It’s paid in a quarterly basis, and in the event that your VAT return and/or payment are not submitted by the due date, you will be in default. At this time there is a 7-day grace period in which you can pay without being penalised, but you remain ‘in default’ for 12 months. You will be sent a Surcharge Liability Notice, which effectively notifies you that while no penalty is yet due, you must make no further errors or miss any due dates within the period you are held in default.

Self-Assessment Tax Returns

There are two deadlines for self-assessment tax returns as a sole trader; if you are submitting on paper your return is due by the 31^st of October. If submitting online (by far the more common method today), you have until the 31^st of January. In either case, your return must cover the previous tax year, running from the 6^th April to the 5^th April. If you are anywhere between 1 day and 3 months late to submit your form, you will be penalised £100 for late filing, and after that the penalty steadily grows. Should you pay late, you will also be charged interest – though there is an appeals process if you have a reasonable excuse. It should go without saying but your tax returns must also be correct; the penalties for errors in your self-assessment vary based on HMRC’s judgement on the nature of the mistake. If HMRC hold that the error was deliberate and concealed, the penalty will be greater than if it was careless, for example.

Contractors and IR35

The Intermediaries Legislation, better known as IR35, was introduced to counter a process known as the ‘disguised employee’. These contractors are taxed as if they were directly employed by their clients – making a major difference to their take-home pay. Whether or not a given role falls within or without IR35 is determined by a complex test which we will not attempt to summarise here. However, as the penalties for incorrectly classifying your role as within IR35 are significant, great care should be taken here. As part of our limited company service we offer a free IR35 review for every contract undertaken. Even if you aren’t working with us, we advise you to verify the IR35 status of each contract you accept.

How Correct Accounting Helps You Get the Most from Contracting

As you’ve seen above, harsh penalties and fines do exist for contractors whose paperwork is submitted late and/or inaccurately. Happily, they can be avoided if you’re organised, honest, and aware of what current legislation means for you. One of the services we offer as contractor and limited company accountants is to ensure all returns are prepared and submitted on time and in full compliance, even as legislation changed. Our goal is to provide peace of mind for our clients. If, having read this guide, you’re unsure of where you stand with any of the above, why not get in touch? We’ll be happy to discuss ways to ensure you’re in compliance and receiving the best of the benefits of a contractor lifestyle.