Accountancy advice for contractors and freelancers including understanding IR35
Reviewed: 2nd November 2017
HMRC can impose significant penalties on freelancers and contractors who fail to comply with their accounting requirements. Maintaining proper books and financial records, and filing tax returns on time, is one of the most important business responsibilities - HMRC can investigate your working practices and tax affairs at any time.
A number of accounting issues need to be considered when working freelance or as a contractor, and although some simply require a consistent approach – completing your books regularly, for example, and filing tax returns when needed – others benefit from a qualified accountant’s input to make your business more tax efficient.
With efficiency in mind, here are just a few suggestions to keep your business finances in order:
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Open a separate business bank account
If you’re a contractor working under your own limited company you’ll automatically need a business bank account, but self-employed freelancers don’t always open a separate account for their business. This can cause confusion when completing the accounts, as business-related expenditure is mixed with personal expenses. - Put money aside each month for your tax bill
The consequences of receiving an unexpected tax bill can be serious, and even affect the long-term viability of your business. Payments on account can be particularly worrying if you’re new to freelancing, as you may need to pay one and a half year’s tax liability in your first year.
It’s important to account for income tax, Class 2 and Class 4 National Insurance contributions at the end of every month, and move the required amounts into a separate interest-earning account to pay your bill at the end of the tax year. - Keep track of your cash flow
It’s much easier to complete your annual tax return when incomings and outgoings are recorded on a monthly basis. You’ll also see your cash needs in the coming months, get an idea of your tax liability throughout the year, and be able to put aside the correct amounts. - Claim your allowable expenses
As a freelancer or contractor you can deduct some of your business expenditure from profits, to reduce your tax liability. If you’re home-based, this includes a portion of the costs of working from home.
Although it may be simpler to use the flat rate available for claiming ‘use of home’ expenses, it would be worthwhile calculating whether you’re losing out by not using the full, more detailed calculation. This is based on the number of rooms in your home, and how much you use them for work
What is IR35 legislation?
The Intermediaries Legislation, commonly known as IR35, was introduced by the government in 2000 as a deterrent to tax avoidance. HMRC believed some contractors were working as ‘disguised employees,’ with both the contractor and their client paying less tax as a result. To combat this, HMRC has the power to demand a ‘status review’ during which they scrutinise the wording in your contracts, and compare this to your working practices.
Calculating your IR35 liability as a contractor
If you’re a contractor providing personal service via your own limited company, it’s important to establish whether you fall under IR35 rules. These essentially mean you would pay tax and National Insurance under the PAYE scheme, rather than taking a small salary from your own company, and the remainder of your remuneration via dividends which attract less tax.
At the end of your company’s tax year you would need to calculate what is termed the ‘deemed payment’ to establish your tax and NI liability under IR35 rules. This involves deducting allowable expenses, plus 5% for the costs of running your company.
From this figure, any employer NICs and your salary should be deducted. If the resulting figure is higher than zero, you’ll be liable for further tax.
For more information and advice on your accounting responsibilities as a freelancer or contractor, or to deal with IR35 legislative requirements, contact our expert team at Real Business Rescue. We have an extensive network of 75 offices offering confidential director support across the UK.
Further Reading on Tax HMRC Vat
Free Guide for Limited Company Directors
Business Rescue Advice for Directors
- How to manage company cash flow problems
- Advice on dealing with HMRC
- Understanding rescue and closure options
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Business Rescue Guide for Accountants
Dealing with your Insolvent Clients
- Helping you advise insolvent clients
- Spotting signs of client distress
- Exploring business rescue options
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