Many contractors work through a Limited Company. Employers like the flexibility of contract work without the downsides of full employment and employee rights, and contractors are happy to offset this reduction in rights with the financial benefits. However, one needs to weigh that up with some potential pitfalls: personal tax, choice of service providers, tax evasion and residency status.

Personal Tax

Most contractors think that the tax paid by their Limited Company covers all of their taxes. Sadly, that's not the case. If you earn more than £15 an hour, or invoice more than £30k a year, you may well end up with a Personal Tax liability at the end of the year. The new Personal Tax Self Assessment regime introduced in the late 90's means that company directors and those taxpayers earning dividend income are obliged to lodge an SA100 Personal Tax Return. As a higher earner, they face the prospect of paying additional personal tax. The principle reason for this is that dividend income only carries with it an imputation credit that covers basic rate tax. However, once you're in the top tax bracket, this credit doesn't cover the full personal tax liability and there is further tax due. There's nothing more infuriating than an unexpected tax liability!

Service Providers

Most contractors nowadays work through a Limited Company service provider. This carries with it some risks: First, your provider can go bust or be put into Administration (like the recent example of Safe Solutions Accounting). If you have money due from them (they essentially control your Limited Company bank account), you could lose your pay. Second, be careful of hidden fees. Providers that highlight low admin fees normally make their money from you elsewhere (a classic example is if they withhold Corporation Tax, and your Limited Company tax bill ends up lower than expected. Who keeps that money? Another example: They collect VAT and deduct PAYE & NI on your behalf - are you certain that they're paying this on to the Revenue (HM Revenue & Customs)? You could be liable for these taxes if they're not paying it over properly. The best way of ensuring that your provider is being straight with you is to a) examine your AFTER TAX earnings and b) make certain that the taxes that they're deducting are in fact being paid over. The lesson here is: don't be fooled by low admin fees.

Tax Evasion

First, let's look at offshore structures. Offshore schemes sound attractive, but they should be a red flag. Not all such schemes flout the tax laws, but if you're working in the UK, and your agency or end-user client is in the UK, then it is very likely that an offshore structure is set up only to evade (not just avoid) tax. Remember, tax avoidance is legal, tax evasion is not. For example, where you get paid a flat 95% from an offshore service provider, then that payment will incur personal tax, as you are obliged to register as Self Employed. Second, IR35 (tax legislation introduced to curb the abuse of personal service companies) compels a contractor to satisfy himself and Revenue that the nature of their work is that of a genuine self employed contractor, and not like that of an employee. And finally, teachers are subject to alternate PAYE and NI treatment even if they work through a Limited Company - so if you're a teacher, make sure that the new rules are being applied to you.

Residency Status

Another critical implication of working through a Limited Company is on one's residency status. It has already been established that a 2 year Working Holiday Visa holder can legitimately work through a Limited Company. Contractors who are wanting to apply for Ancestry, Work Permits or Highly Skilled Migrant Visas must show evidence of having paid tax (PAYE and National Insurance), or their applications will be denied. Examples abound of contractors being denied visas, despite having been legally resident in the UK for their full 4 or 5 years, simply because they have been operating through a Limited Company provider that has not properly administered their financial and tax affairs.