When you work as a contractor in the UK, you typically operate through one of two structures:
A third route — sole trader / self-employment — is used by some contractors but is less common for day-rate work as it offers fewer tax advantages than a limited company.
The key tax advantage of a limited company (outside IR35) is that you can split your income between salary and dividends. Dividends are taxed at lower rates than salary and are not subject to National Insurance contributions.
| Feature | PAYE Employee | Ltd Company Contractor |
|---|---|---|
| Income tax | 20%–45% on all income | Corp tax on profit, then income tax on salary + dividends |
| National Insurance | Employee + employer NI (total ~25%) | Only on salary portion (usually kept low) |
| Dividend tax | N/A | 8.75% (basic), 33.75% (higher rate) |
| Holiday pay | Paid by employer | You fund your own (factor in 20–25 days) |
| Sick pay | Statutory sick pay minimum | None — you fund your own |
| Pension | Auto-enrolled by employer | Self-arranged — director's pension contributions |
| IR35 risk | N/A | Significant — must be assessed per engagement |
| Admin | None (employer handles) | Company accounts, corp tax return, VAT (if registered) |
IR35 (officially the "off-payroll working rules") is HMRC's mechanism for determining whether a contractor is genuinely self-employed or effectively operating as a "disguised employee."
If HMRC determines that your contract falls inside IR35, you must pay income tax and NI as if you were an employee — eliminating most of the tax advantages of operating via a limited company.
Key IR35 tests HMRC applies:
Since April 2021, medium and large private-sector companies must assess IR35 status for their contractors (not the contractor themselves). Small clients are still the contractor's responsibility to assess.
Important: If you are operating via a limited company and your contract is inside IR35, the tax difference can be substantial — tens of thousands of pounds per year. Always get IR35 contracts assessed by a specialist before starting an engagement. This guide provides general information; it is not legal or tax advice.
Let's compare the same day rate — £500/day — across two structures, assuming 220 working days per year (£110,000 gross annual revenue), outside IR35.
Personal allowance: £12,570
Basic rate tax (£37,700 × 20%): £7,540
Higher rate tax (£59,730 × 40%): £23,892
Total income tax: £31,432
National Insurance (employee, 8%/2%): ~£5,786
Net take-home: ~£72,782/year — £6,065/month
Salary (at personal allowance): £12,570 — no income tax, minimal NI
Company expenses (accountancy, equipment, etc.): ~£3,000
Corporation tax on profit (£110,000 − £15,570 = £94,430 × 25%): ~£23,608
Post-tax profit available as dividends: ~£70,822
Dividend tax: £2,000 allowance free, remainder at 33.75% (higher rate): ~£23,150
Net take-home: ~£60,242/year — £5,020/month
Note: this example uses 25% corporation tax (main rate) and assumes the contractor is in the higher-rate dividend band. A specialist accountant can often improve this significantly through pension contributions, timing of dividends, and other planning.
The numbers above show that the headline "contractors earn more" narrative is complicated by corporation tax rates (raised to 25% for profits over £250,000 and small profits rate of 19% for profits under £50,000) and IR35 risk. A specialist contractor accountant will typically charge £100–£150/month and can identify significant savings.
When comparing a day rate to a salary, contractors must factor in costs that employers absorb for permanent employees:
A simple rule of thumb: your day rate needs to be roughly 1.5× the daily equivalent of a comparable PAYE salary to achieve similar after-costs take-home pay — and that ratio rises to 2× or more in IR35 sectors with frequent gaps.
There is no single right answer. The optimal structure depends on:
For most high-day-rate contractors (£400+/day) working outside IR35, a limited company with proper accountancy still offers significant tax advantages — but the gap has narrowed considerably since 2017 IR35 reforms and the 2023 corporation tax increase.
For lower-rate contractors or those inside IR35, an umbrella company is often simpler and financially similar to PAYE.
Always consult a specialist contractor accountant before making a decision. The right structure for your situation can save tens of thousands of pounds per year.
See income tax and National Insurance for any UK salary in 2026/27.
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