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Understanding the UK’s tax system

The UK’s tax system might seem complicated if you’re new to the country. But, once you understand how it works, you can use it to your advantage and possibly save yourself some money.

 

The basics

The UK tax year runs from 6 April to 5 April the following year.

You pay two types of tax in the UK:

• Pay as You Earn (PAYE)
• National Insurance (NI)

Pay As You Earn (PAYE)

This follows a simple equation: The more money you earn in the UK, the more tax you pay. The first £10,600 of your income in a financial year is completely tax-free. The next £21,185 is taxed at 20%, while income falling between £43,000 and £150,000 is taxed at 40%. Any portion of your income that exceeds £150,000 a year will be taxed at 45%.

National Insurance contributions

Along with PAYE, you are also required to pay up to 12% of your gross salary income as an NI contribution. The first £8,064 you make in a financial year is not taxed for NI purposes.

If you earn between £8,064 and £42,384 per year, you are taxed at 12%. Anything over this is taxed at an additional 2%. These contributions are represented at the bottom of your payslip and are divided into:

  1. National Health Service
This goes towards funding government doctors and hospitals in the UK, enabling you to use the public health system for free.
  2. UK pension scheme
This is a retirement fund set up for you in the UK.

During your time in the UK, you may work for more than one employer. On your last day of employment at your current company, you will receive a P45. This document indicates the total the amount of tax paid whilst you were working for that employer. If you hold various jobs throughout the financial year then you would have multiple P45s.

Every year, your as at 5 April, must give you a P60. This is given to you once a year and only on the final day of the tax year. This document sums up the total tax paid on your behalf during the financial year. You must keep these documents to claim for a tax refund.

If you choose to work through tax structures in the UK, there will be other taxes that apply. If carefully managed, you are able to maximise your income through these structures.

Salaried employee or PAYE

As an employee, your recruitment agency or employer is responsible for deducting the PAYE, Income Tax and National Insurance at source, with little to no involvement or costs on your side. Agencies and employers with whom you have a long term employment contract will often require that these taxes are deducted in this way.

Self-employed

To register as self-employed, you simply need to contact HM Revenue and Customs (HMRC) within three months of starting work. Registering as self-employed is the simplest way for a contractor to start their own business.

Agencies and clients pay into your account and you pay yourself. You are usually taxed at one of the higher tax rates and will be responsible for paying your taxes yourself.

The level of ongoing administration is relatively low, which should translate into lower accounting fees.

Payroll or umbrella service companies

Payroll or umbrella companies act as third party employers for contractors. As a result, these structures usually have more benefits than a self-employed set-up.

An umbrella company is responsible for all back office administration, such as invoicing and payroll. With these setups, clients can afford to pay premium or “company” rates to contractors. You will have little to no extra administration than if you were a PAYE employee of your agency or client.

However, as of 6 April 2016, new legislation makes payroll or umbrella companies a much less attractive option than they once were. Temporary workers, including those under umbrella companies or through agencies, will no longer receive tax relief on travel and subsistence costs.

Limited company

When you set up a limited company, your agency or client pays into the company’s business bank account. You then use these funds to pay yourself with a combination of salary, expenses and dividends (the best combination can be discussed with an accountant or financial adviser). You can find out more about contracting through a limited company here.

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