While the taxman is inescapable, there are ways of reducing the amount you pay and ensuring you maximise your situation. One of these ways is by determining the way in which you are paid. In the UK, there are two main options you can choose: Pay As You Earn (PAYE) is the most common, while Limited Companies are a popular choice for many travellers wishing to maximise their after-tax earnings, especially for those who contract.
PAYE tax
The most common taxation status for Aussies, Kiwis and South Africans working in the UK is the Pay As You Earn (PAYE) taxation scheme whereby tax is deducted by your employer prior to you receiving your pay. PAYE tax is made up of income tax and National Insurance. During your UK employment, you will be issued with P45s when you complete a job and a P60 form at the end of the tax year. You will need to keep these documents if you wish to claim a tax refund.
Contractors
Contractors have two options in the UK when it comes to paying tax and getting paid. You can either form your own limited company, known as a Personal Service Company (PSC), or you can use a so-called umbrella company to do the hard work for you.
The main factor that will affect your choice is legislation known as IR35. This legislation was designed to distinguish ‘disguised employees’, acting as contractors simply to avoid taxes, from contractors working in a genuine self-employed nature who need a system to administer their tax.
Personal service companies (PSC)
Setting up a PSC is the most tax efficient route for a contractor. You’re registered as company director and responsible for all the company’s affairs and finances. PSCs are easy to set up but there’s a fair bit of paperwork involved.
Hire a good accountant and they’ll do most of the work for you.
Provided your contract falls outside IR35, you can keep your yearly taxes to an absolute minimum. You draw a small salary and are then entitled to receive dividends. These attract a lower tax rate than normal income tax rates.
PSC's allow you to retain control over your finances and to claim on a wider range of expenses than with an umbrella company.
If your contract is caught by IR35, you must be paid through PAYE, which includes National Insurance, and you cannot draw dividends.
The IR35 legislation is a very complex subject and it’s vital that you seek expert advice to ensure your contracts fall outside IR35, or you could face back payments and even fines if investigated.
Umbrella companies
Umbrella companies remove the hassle of administration for people who freelance or contract. You just send them your time sheets and expenses and they do the rest.
Umbrella companies pay you through PAYE regardless of your IR35 status, so there are no tax breaks. If your contracts fall outside IR35, your financial returns will be significantly reduced by paying tax this way.
The main point of using an umbrella company rather than going straight to an agency is that you can claim back expenses. » Umbrella companies charge you a fee to administer your taxation, which is normally between £15 and £35 per week.