A UK contractor limited company faces tax in two layers: corporation tax on the company’s profits, and personal tax on whatever you extract as salary or dividends. Contractor limited company tax planning centres on getting that split right, usually by paying yourself a small salary at or near the personal allowance and drawing the rest as dividends from post-tax profits. Sitting alongside that core decision are VAT, IR35, pension contributions, and a set of filing deadlines that carry penalties whether or not you owe any tax.
Corporation Tax on Company Profits
Your company pays corporation tax on its annual profits, which is revenue minus allowable business expenses. Expenses qualify only if they were incurred wholly and exclusively for business purposes.1HM Revenue & Customs. Business Income Manual – BIM37007 – Wholly and Exclusively: Overview Personal costs pushed through the company don’t reduce the bill.
The rate depends on the size of the profit. Companies with profits under £50,000 pay the small profits rate of 19%. Those with profits above £250,000 pay the main rate of 25%.2GOV.UK. Rates and Allowances – Corporation Tax Between those thresholds you pay 25% but receive marginal relief that tapers the effective rate down toward 19%. The formula takes the gap between £250,000 and your profits and multiplies it by 3/200 (1.5%), reducing the tax bill by that amount. A company earning £100,000 in profit ends up with an effective rate of roughly 21.5%.
Corporation tax is worked out on the accounting period, normally 12 months aligned with the company’s financial year. If you control other companies through yourself or close family, the £50,000 and £250,000 thresholds get divided between them, which can push the effective rate up.
Paying Yourself: Salary and Dividends
The heart of contractor tax planning is the salary/dividend split. A low salary through payroll, then dividends from retained profits for the rest. Dividends carry no National Insurance, so shifting income away from salary and toward dividends reduces the overall burden.
Why the Salary Sits at £12,570
Most contractors set the salary at or around £12,570, matching the personal allowance. At that level there’s no income tax on it because the allowance covers it.3GOV.UK. Income Tax Rates and Personal Allowances It also earns a National Insurance credit toward the state pension, where 35 qualifying years are needed for the full amount. The company deducts the salary as a business expense, reducing corporation tax.
The cost is employer National Insurance. From April 2025 the employer NI rate is 15%, kicking in above the secondary threshold of roughly £96 per week, about £5,000 a year.4GOV.UK. Rates and Allowances – National Insurance Contributions A £12,570 salary therefore generates employer NI on the portion above £5,000, around £1,135 a year. Whether that cost pays for itself in corporation tax savings depends on the company’s profit level and whether the Employment Allowance is available.
Employee NI is 8% between the primary threshold of £12,570 and the upper earnings limit of roughly £50,270, then 2% above that.5GOV.UK. National Insurance – How Much You Pay Set the salary exactly at £12,570 and your personal NI bill is essentially nil, because the primary threshold and personal allowance sit at the same figure. That alignment is why £12,570 is the default choice.
Dividends and the Tax Bands
Dividends come from profits already taxed at corporation tax rates, so dividend tax rates are lower than income tax on equivalent salary. For 2026/27 the first £500 of dividends falls within the dividend allowance and is taxed at 0%.6GOV.UK. Tax on Dividends After that the rates are:
- Basic rate (£12,571 to £50,270 of total income): 8.75%
- Higher rate (£50,271 to £125,140): 33.75%
- Additional rate (above £125,140): 39.35%
Dividends stack on top of salary when working out which band applies. Take £12,570 in salary and £37,700 in dividends and your total income lands at £50,270, exactly at the top of the basic rate band. Push dividends higher and the excess falls into the higher rate. Dividends can only be declared when the company has enough retained profits after debts and liabilities. Paying dividends out of non-existent profits is unlawful and can create personal liability for directors.
Employment Allowance
The Employment Allowance lets eligible employers cut their annual employer NI bill by up to £10,500.7GOV.UK. Employment Allowance The employer NI on a £12,570 salary is around £1,135, so the allowance wipes it out entirely when it applies. Eligibility depends on the company’s circumstances, and companies where the sole employee is also the sole director may face restrictions. Check the criteria before relying on it.
Employer Pension Contributions
Paying employer pension contributions straight from the company is one of the most efficient extraction routes. They count as an allowable business expense (reducing corporation tax), generate no National Insurance for company or director, and aren’t taxed as personal income when paid. Normal pension rules apply when the money is eventually drawn in retirement.
Contributions must still meet the “wholly and exclusively” test, which in practice means they should be reasonable relative to the director’s role and the company’s profits. A contractor with £80,000 in profits making a £40,000 employer pension contribution would likely draw HMRC scrutiny; contributions of £10,000 to £20,000 alongside a normal salary-and-dividends package are routine. The annual allowance, combining employer and personal contributions, is £60,000, and unused allowance carries forward from the previous three tax years.
Director’s Loan Account Pitfalls
Any money you take out of the company that isn’t salary, dividend, or expense reimbursement lands on your director’s loan account as a debt owed back. Borrowing from your own company feels harmless, but HMRC treats overdrawn director’s loan accounts seriously.
If the loan isn’t repaid within nine months and one day after the end of the accounting period, the company pays a Section 455 charge of 33.75% on the outstanding balance.8GOV.UK. Directors Loans – If You Owe Your Company Money The company gets that tax back once the loan is repaid, but the cash flow hit is real. Separately, if the loan exceeds £10,000 at any point in the tax year, HMRC treats the official interest rate benefit as a taxable benefit in kind, triggering additional personal tax and a P11D filing. The cleanest approach is to avoid overdrawn positions and take any surplus cash as a properly declared dividend instead.
Allowable Expenses and Capital Allowances
Every pound of legitimate expense cuts corporation tax. Common deductions for contractors include accountancy and bookkeeping fees, professional indemnity insurance, business travel (including mileage at approved rates), telecommunications costs, software licences, training tied to the current role, and working-from-home costs where part of the home is used regularly for business.
Larger purchases like laptops, monitors, or office furniture fall under capital allowances. The Annual Investment Allowance lets you deduct up to £1,000,000 of qualifying capital expenditure in the year of purchase. Cars are excluded and have their own rules based on CO2 emissions. Most contractors won’t get anywhere near the £1,000,000 ceiling, but qualifying equipment can be written off in full rather than spread across several years.
VAT Registration
Your company must register for VAT once its taxable turnover in any rolling 12-month period reaches £90,000.9HM Revenue & Customs. Increasing the VAT Registration Threshold Day-rate contractors often cross that quickly. Some register voluntarily below the threshold to reclaim VAT on business purchases, which only makes sense if the end clients are themselves VAT-registered and can recover the VAT you charge.
Under standard VAT accounting you charge VAT on invoices (usually at 20%), reclaim VAT on business purchases, and pay the difference to HMRC each quarter. The Flat Rate Scheme simplifies things: you pay a fixed percentage of gross turnover instead of tracking input tax on every purchase.10GOV.UK. Flat Rate Scheme for Small Businesses – VAT Notice 733 The percentage varies by industry, but most contractors fall into the “limited cost trader” category because they spend relatively little on goods. Limited cost traders pay 16.5%, which strips out most of the financial advantage the scheme used to offer. A limited cost trader is any business spending less than 2% of its flat rate turnover on relevant goods (or under £1,000 a year if that figure is higher). For IT contractors, consultants, and similar service-based work, the scheme’s only real upside now is administrative simplicity.
Off-Payroll Working Rules (IR35)
IR35 is the shorthand for the off-payroll working rules in Chapter 10 of the Income Tax (Earnings and Pensions) Act 2003.11Legislation.gov.uk. Income Tax (Earnings and Pensions) Act 2003 They target contractors who would be employees if they worked for the end client directly rather than through their own company. Income from a contract that falls inside IR35 is taxed as employment income, with full income tax and NI deducted. That wipes out the salary-plus-dividends efficiency.
Since April 2021, medium and large end clients decide whether an engagement is inside or outside IR35 and must issue a Status Determination Statement setting out their reasoning. If the end client qualifies as “small” under the Companies Act 2006, the decision (and the risk) stays with you as the contractor. When the client makes the determination, they also carry the liability if HMRC later disagrees.
Three factors dominate status assessments, though none is decisive on its own:
- Right of substitution: can you send someone else to do the work? A genuine, unfettered right to substitute is a strong indicator of self-employment. If the client can veto any substitute, it points toward employment.
- Control: does the client dictate how, when, and where you work? Contractors who set their own hours, methods, and location look like businesses; those tied to the client’s desk and schedule look like employees.
- Mutuality of obligation: is the client bound to offer ongoing work, and are you bound to accept it? Employment relationships typically involve that mutual commitment beyond any single task.
Being ruled inside IR35 after operating as if outside triggers back-payments of tax and NI plus interest. Where the client makes the determination, the fee-payer (often a recruitment agency) usually bears the liability. In small-company engagements where you self-assess, the liability sits with your own company. Either way, the exposure is large enough to justify a formal status review from a specialist before starting a new contract.
Filing Deadlines and Penalties
Two separate deadlines run after the end of each accounting period. Corporation tax must be paid within nine months and one day. The CT600 corporation tax return must be filed within 12 months.12GOV.UK. Company Tax Returns The two run independently, so a company can owe no tax and still be penalised for a late return.
Late filing penalties escalate on a fixed schedule:13GOV.UK. Company Tax Returns – Penalties for Late Filing
- 1 day late: £100
- 3 months late: another £100
- 6 months late: HMRC estimates the tax bill and adds a penalty of 10% of the unpaid tax
- 12 months late: another 10% of any unpaid tax
File late three times in a row and the £100 penalties rise to £500 each. Returns go through HMRC’s online services via a Government Gateway account, and payments run through BACS, CHAPS, or Direct Debit. Corporation tax filings are only half of it: annual accounts also go to Companies House within nine months of the financial year end, and a confirmation statement is due at least once every 12 months. Companies House penalties for late accounts run separately from HMRC penalties, so missing both deadlines means two sets of fines from two different bodies.14GOV.UK. Filing Your Companys Confirmation Statement HMRC can request supporting records for up to six years after the end of the relevant accounting period, so keep everything even after the return is filed.15GOV.UK. Accounts and Tax Returns for Private Limited Companies