What’s the least taxing way to join an agency’s retainer for a few months?

Freelancer’s Question: I work in digital marketing and have been asked to join an agency under a retainer agreement for three months.

Freelancers’ Questions: What’s the least taxing way to join an agency’s retainer for a few months?

I’m not 100% au fait with such agreements, but the retainer monthly payment is about £2,500, yet I’m not sure how much tax I would pay. Is there an estimate please; would it be the same as PAYE? 

If it helps to know, I have a limited company set up from a while ago which I could use. 

Also please, what are the tax rules are on using a car for business? I bought a car, got insurance and paid road tax. How much of this total cost can I put down as business use if I decide to use the car for working with this agency?  I use the car for social purposes too but want to know if it’s worthwhile for work. Public transport right now is not very appealing!

Expert’s Answer: For the purpose of answering your query here, as you have a limited company set up already, I will assume that the income from this retainer will go through the limited company (even if it is currently dormant).

As a company, you will pay corporation tax on your profits at 19%. Profit is calculated by subtracting your expenses from your income and this is calculated based on your company year. Any money received then belongs to the company until it is declared as a dividend. The amount of tax that you pay on this income will then depend on your total income for the tax year (being April 6th to April 5th the following year), from all places that you receive income.

Basic or higher?

A basic rate taxpayer will pay tax on dividends at 7.5%, and a higher rate payer at 32.5%. Ordinarily, the combination of corporation tax and dividend tax will be lower than the combination of income tax and national insurance that is paid on the profits of a sole trader. As a basic rate taxpayer, you can expect to retain about 75% of your income (assuming all is paid out as a dividend – which it doesn’t need to be) if you are trading as a limited company. 

And the fact that the income is a retainer rather than a one-off project simply means that it is going to be recurring revenue (presumably monthly). The revenue that you earn in a year will be totalled and costs deducted to calculate the profit subject to tax.

If you plan to operate as a sole trader, you are going to pay income tax plus national insurance on your profits. Income tax is at 20% if a basic rate taxpayer and 40% if a higher rate tax payer, whereas national insurance is (broadly, not exactly) 9% as a basic rate taxpayer and 2% as a higher rate taxpayer – meaning effective rates of tax of 29% and 42%, respectively. 

Differing rules

In terms of the car, the rules differ for sole traders and limited companies. As a sole trader, you can claim the proportion of your motoring costs which relate to business travel – so if the car is used 25% for business and 75% personal, you could claim 25% of the cost of the car (as a capital allowance), plus 25% of all other motoring costs.

As a limited company, the car should be in the name of the limited company and you would be able to claim capital allowances on the cost of the car – however, the car would be treated as a Benefit-in-Kind (BIK) if it was available for private use, and taxed accordingly. Generally-speaking, unless the car had great environmental credentials (as the BIK is calculated based on the cars CO2 emissions), then it is not tax-efficient to treat it in this way, as the benefit-in-kind tax will outweigh then tax relief available. 

It may be more tax-efficient (and simpler) to claim business mileage rather than the car itself – business mileage is claimable at 45p per mile for the first 10,000 miles and 25p per mile thereafter. This allowance is reset each tax year. Good luck!

The expert was Craig McCall, director at Alchemy Accountancy, an accountancy firm serving freelancers and the self-employed.