IT contracting in the UK typically means higher day rates than permanent roles, but it also means taking on accounting and tax responsibilities that permanent employees never face. Most IT contractors operate through a limited company (a Personal Service Company), and the way you extract money from that company has a significant impact on how much you keep after tax.
Choosing the Right Structure
| Structure | Best For |
|---|---|
| Limited company (PSC) | Contractors outside IR35 earning above £50,000; maximum tax efficiency |
| Umbrella company | Contractors inside IR35 or those who want zero admin |
| Sole trader | Short-term, low-value work; rarely used by IT contractors |
If your contracts are outside IR35, a limited company lets you take advantage of the salary-dividend split, employer pension contributions and a range of deductible expenses. If your contracts are inside IR35, the tax advantage of a limited company largely disappears and an umbrella company is simpler.
IR35: What IT Contractors Need to Know
IR35 is the single biggest factor in IT contractor accounting. The off-payroll working rules determine whether you are taxed as an employee or as a genuine business.
Who Decides?
Since April 2021, for medium and large private sector clients, the end client determines your IR35 status. For small clients (within the Companies Act small company limits on turnover, balance sheet total and employees, as applied to the off-payroll rules), the contractor’s own company makes the determination.
Key Indicators
| Factor | Outside IR35 | Inside IR35 |
|---|---|---|
| Control | You decide how, when and where the work is done | The client dictates methods, hours and location |
| Substitution | You can send a suitably qualified replacement | The client expects you personally |
| Mutuality of obligation | No obligation to offer or accept work between contracts | Ongoing obligation even between projects |
| Equipment | You provide your own laptop, software and tools | The client provides all equipment |
| Financial risk | You quote fixed prices and bear the risk of overruns | You are paid by the day regardless of output |
Always obtain a Status Determination Statement (SDS) from your end client and keep it on file.
The Salary-Dividend Strategy
For contractors operating outside IR35 through a limited company, the standard approach is:
| Component | Typical level | Rationale |
|---|---|---|
| Annual salary | At or near the personal allowance | Little or no income tax or employee NIC; a salary above the Lower Earnings Limit records a qualifying year for the State Pension |
| Employer pension contributions | Variable | Tax-deductible for the company; no income tax or NIC for the director |
| Dividends | Remaining profits after Corporation Tax | Taxed at the dividend ordinary, upper or additional rate above the dividend allowance |
On a day rate of £500 over 220 working days (£110,000 gross revenue), a contractor outside IR35 can often save a five-figure sum each year compared to taking the same amount through PAYE, depending on the tax rates for the year.
Director’s Salary Considerations
Setting the director’s salary at the right level balances several factors:
- Between the Lower Earnings Limit and the Primary Threshold: no employee NIC, but the year still counts for the State Pension
- Above the Primary Threshold: employee NIC applies
- Employer NIC: starts at the Secondary Threshold, which can sit well below the Primary Threshold
Where the Secondary Threshold is lower than the personal allowance, a salary at the personal allowance creates some employer NIC, so the best level depends on whether the company can claim the Employment Allowance. Review the thresholds each April, when the government can change them; HMRC publishes the current figures on GOV.UK.
Allowable Expenses
IT contractors can claim expenses incurred wholly and exclusively for business purposes:
| Expense | Deductible? |
|---|---|
| Professional indemnity insurance | Yes |
| Public liability insurance | Yes |
| Accounting and tax advice | Yes |
| Software licences (IDE, cloud services, dev tools) | Yes |
| Hardware (laptop, monitors, peripherals) | Yes |
| Training related to current skills | Yes |
| Travel to temporary workplaces | Yes (subject to 24-month rule) |
| Subsistence while travelling | Yes |
| Home office (flat rate £6/week or actual proportion) | Yes |
| Mobile phone (company contract) | Yes |
| Co-working space fees | Yes |
| Client entertaining | Not deductible for Corporation Tax |
The 24-Month Rule
You can claim travel and subsistence to a temporary workplace. If you work at the same client site for more than 24 months (or know you will), it becomes a permanent workplace and travel expenses are no longer deductible.
Track your time at each client site carefully. If a contract is extended and will take you past 24 months at the same location, stop claiming travel from the point you know this.
VAT for IT Contractors
Most IT contractors earning over £90,000 must register for VAT. Since your clients are typically VAT-registered businesses, charging VAT does not affect your competitiveness – they reclaim it.
The Flat Rate Scheme can simplify your VAT admin. For IT consultancy, the flat rate is typically 14.5% of gross turnover, meaning you charge 20% VAT but pay 14.5% to HMRC and keep the difference.
However, if you are a limited cost trader (goods cost less than 2% of turnover), the flat rate is 16.5%, which usually makes the standard VAT scheme more attractive.
Corporation Tax Planning
Your limited company pays Corporation Tax on its profits:
| Profit Level | Rate |
|---|---|
| Up to £50,000 | 19% (small profits rate) |
| £50,001-£250,000 | 26.5% (marginal relief applies) |
| Over £250,000 | 25% (main rate) |
Reducing taxable profit through allowable expenses and pension contributions lowers your Corporation Tax bill. Employer pension contributions are one of the most tax-efficient ways to extract profit because they avoid both Corporation Tax and personal tax.
Record-Keeping
Maintain clean, organised records from day one:
- Invoices to clients and agencies, with payment dates
- Receipts for all business expenses (photographed or scanned)
- Bank statements for the business account
- Mileage log if claiming vehicle expenses
- Contracts and IR35 Status Determination Statements
- Time sheets or project records showing hours worked
Keep records for at least 6 years from the end of the accounting period.
Key Deadlines
| Deadline | Filing |
|---|---|
| On or before payday | RTI submission for director’s salary |
| Quarterly | VAT return (if registered) |
| 9 months + 1 day after year end | Corporation Tax payment |
| 9 months after year end | Annual accounts filed at Companies House |
| 12 months after year end | CT600 filed with HMRC |
| 31 January | Personal Self Assessment return |
| Annually | Confirmation statement at Companies House |
Common Mistakes
- Not getting IR35 right – if your contract is inside IR35 and you take dividends, HMRC will pursue the tax difference plus penalties
- Continuing to claim travel after 24 months – this is heavily scrutinised
- Not paying Corporation Tax on time – interest accrues from day one
- Mixing personal and business spending – use a dedicated business bank account
- Ignoring pension contributions – they are one of the most tax-efficient extraction methods available
- Not reviewing your structure when IR35 status changes between contracts