Words and phrases you need to know when contracting

Contracting can be an excellent way to make a living, but there are terms and responsibilities that you need to be aware of beforehand...

Whether you are new to contracting or are experienced in the field, there are likely to be phrases you come across that are confusing and do not have an obvious meaning, such as:

The IR35 legislation determines whether you are permitted to work as a limited company contractor or not.

If you decide when, where and how you work, it is likely you will fall outside the regulation and will be able to operate as a limited company. However, if the client imposes these working conditions on you, HM Revenue and Customs will probably consider you to be an employee and you should look for alternatives, such as utilising the services of an umbrella company.

Corporation Tax
This is levied on the taxable profits of limited companies and is usually paid once a year – traditionally nine months after the end of your company’s fiscal accounting period. This is not something umbrella contractors need to worry about.

Income Tax
Most earnings – including your salary, pensions income, interest on savings and profits on share portfolios – are subject to income tax. This is paid monthly through a Pay As You Earn (PAYE) payroll system.

Limited company contractors can choose the level of salary they withdraw, potentially reducing the amount of income tax and National Insurance they are required to pay. This is a perfectly legal practice and there are a number of limited company service providers that can assist you. More information can be found here.

National Insurance
You are entitled to certain state benefits because of your record of making National Insurance payments – which also fund the National Health Service. Your state pension, jobseeker’s allowance, bereavement allowance and employment and support allowance all result from this deduction, which is usually paid as part of the PAYE payroll.

Again, it is perfectly possible – and legal – for limited company contractors to withdraw a minimal salary and high dividends, thus reducing the amount of National Insurance they are required to pay. However, many contractors choose to ensure their contribution is covered.

Umbrella Company
If you do not wish to set up a limited company – or are not permitted to do so as a result of IR35 – you can still access a similar status through the use of an umbrella company.

You become an employee of the umbrella company meaning that the umbrella company takes care of all National Insurance and tax deductions on your behalf. All the contractor is required to do is complete a timesheet and claim expenses, which can now be done online in many cases.

Furthermore, invoices and expenses claims are submitted to the company, leaving you free to concentrate on contracting or your life outside of work.

Depending on the umbrella company you choose, you may be able to access additional benefits, including professional indemnity insurance.

Professional Indemnity Insurance
Such policies protect investors against claims for professional negligence. If a contractor’s actions result in a financial loss for the client and they choose to sue, the policy will cover legal costs and any resulting damages.

Many recruitment agencies will insist that contractors hold a policy such as this, with the minimum value often around £1 million.