Accounting for IT Contractors

“Most contractors don’t fail because of the work they do. They fail because of the paperwork they ignore.”

I heard that line very early in my career. It stuck with me because, over the years, I’ve seen exactly how true it is.

I remember working with an IT contractor — let’s call him Mark — who was brilliant at solving complex data migration issues but had never filed a VAT return on time. Not once. He was drowning in receipts stuffed into a backpack that looked like it had seen the inside of every train carriage in the South East. Mark wasn’t unusual. In fact, he was exactly like most contractors I’ve met over the last decade: excellent at the technical craft, overwhelmed by the background admin.

If that sounds familiar, you’re in the right place.

This guide is here to make the world of accounting for IT contractors clearer, simpler, and far less stressful. Whether you're a seasoned contractor or just taking the leap from permanent employment, understanding your accounting responsibilities can save you thousands of pounds, protect you from HMRC scrutiny, and help you make confident financial decisions.

Let’s walk through what you really need to know.

What Is the Difference Between a Contractor and an Employee for Tax Purposes?

It sounds simple, but this is a topic many contractors misunderstand. The difference between being treated like a contractor and being treated like an employee can completely change your tax obligations — and your risk level.

Key Factors HMRC Uses to Determine Employment Status

HMRC doesn’t care what your contract says on the front page. They care about the reality of your working relationship. Three main factors dominate their thinking:

1. Control

Who decides how you work, where you work, and when you work?

If the client tells you exactly how to perform the job, you're drifting into employee territory.

2. Substitution

Can you send someone else to do the work?

Most employees can’t. True contractors often can (provided it’s a genuine right, not just a clause gathering dust).

3. Mutuality of Obligation (MOO)

Is the client obliged to offer you ongoing work? Are you obliged to accept it?

Employees typically get ongoing work. Contractors don’t.

Why Employment Status Matters for Tax and IR35

Because if HMRC decides that you look like an employee — even if you have a limited company — you may fall inside IR35. And IR35 means higher tax, less flexibility, and often a hit to take-home pay.

Examples of Contractor vs Employee Working Arrangements

A contractor typically operates like this:

• Works on specific projects

• Has multiple clients over time

• Uses their own equipment

• Decides when to take time off

• Can refuse work

An employee tends to:

• Work fixed hours

• Have performance reviews

• Receive benefits like holidays and sick pay

• Work under close supervision

One contractor I worked with, Sarah, a cybersecurity specialist, once told me she knew IR35 was a risk the moment her client invited her to the company Christmas party as staff. She politely declined, but the point was clear: the line between contractor and employee can blur quickly if you're not careful.

How Do I Decide Whether to Operate as a Sole Trader or Limited Company?

This is one of the biggest decisions new contractors face.

Tax Differences Between Sole Trader and Limited Company

Sole traders pay Income Tax and National Insurance on their profits. It’s simpler, but often more expensive.

Limited companies pay Corporation Tax and allow you to take money as salary and dividends — often more tax-efficient, especially if your income is above £35,000–£40,000.

Liability and Legal Protection

Sole traders are personally liable for business debts.

Limited companies separate you from the business. If something goes wrong, your personal assets are protected (with some exceptions).

Setup Costs and Administration

A sole trader can start working in a day.

A limited company requires:

• Incorporation

• Separate bank accounts

• Annual accounts

• Corporation tax returns

But once set up, the benefits usually outweigh the admin.

When Contractors Typically Benefit From a Limited Company

Most IT contractors working with agencies or medium/large businesses operate through limited companies. Why? Because:

• Clients prefer it

• You look more professional

• You keep more of what you earn

• It helps you manage IR35 more effectively

You rarely see long-term IT consultants operating as sole traders, especially in fields like cloud engineering, DevOps, software development, and cybersecurity.

What Records Do I Need to Keep as an IT Contractor?

If you only take one lesson from this article, take this:

Good recordkeeping is the secret to staying compliant — and staying profitable.

Financial Records for HMRC Compliance

Keep records of:

• Sales invoices

• Bank statements

• Receipts and expenses

• Dividend vouchers

• Payroll records

• VAT returns

I once had a contractor hand me a Tesco bag full of petrol receipts from three years earlier. Don’t be that person! Use cloud software.

Contract and IR35 Documentation

Keep:

• Contracts

• Statements of Work

• IR35 status assessments

• Status Determination Statements (SDS)

• CEST results

These protect you if HMRC ever asks questions.

Expense Records You Must Maintain

If you claim it, save evidence for it:

• Travel

• Equipment

• Software

• Training

• Subscriptions

If it’s not documented, it doesn’t exist.

How Long to Keep Contractor Accounting Records

HMRC requires at least 6 years.

I recommend seven — just to sleep easier at night.

How Often Do I Need to File Accounts and Tax Returns?

This is where many contractors fall behind.

Annual Filing Requirements for Limited Companies

• Annual accounts to Companies House

• Corporation Tax return (CT600) to HMRC

VAT Filing Schedule

Usually quarterly, unless you choose the annual scheme.

Self-Assessment Deadlines

If you're a director, you must file a tax return every year — even with no income outside the company.

Deadline: 31 January.

Penalties for Late Filing

They escalate fast:

• £150 late accounts

• £100 late Self-Assessment

• Interest and surcharges

A late filing once cost a contractor £800 simply because he forgot to open a letter from HMRC. It happens more than you’d think.

What Are My Responsibilities If I Hire Subcontractors?

Some IT contractors grow into small consultancies and bring people on board.

Status Checks and IR35 Considerations

You must ensure subcontractors are genuinely independent.

CIS Applicability

Rare for IT, but applies if you touch construction-related work.

Contracts and Payment Records

Always keep:

• Contracts

• Invoices

• Payment schedules

Insurance and Risk Management

If you bring people into your business, your risk increases — so make sure your cover is up to date.

What Insurance Do IT Contractors Need?

You won’t just need insurance — many clients require it.

Professional Indemnity Insurance (PI)

Covers claims arising from mistakes in your work.

Public Liability

Protects you if you cause property damage or injuries.

Employer’s Liability

Required if you hire staff.

Cyber Liability

Growing fast in importance, especially for IT professionals.

How Do I Know if My Contract Is Inside or Outside IR35?

IR35 is the single most confusing part of contracting.

Here’s how you make sense of it.

Key IR35 Status Tests

HMRC focuses on:

• Control

• Substitution

• MOO

• Financial risk

• Integration with the client’s organisation

Reviewing Working Practices

Your day-to-day behaviour matters just as much as your contract wording.

Importance of Contract Wording

A clean contract with messy working practices is a red flag. They must match.

Using HMRC’s CEST Tool

CEST can help — but isn’t perfect. Treat it as part of your evidence, not the whole story.

Who Decides My IR35 Status — Me or the Client?

It depends.

Public Sector and Medium/Large Private Sector Clients

They decide your status. They must issue a Status Determination Statement (SDS).

Small Clients

You decide your own IR35 status.

What Clients Must Include in an SDS

• Status decision

• Reasons for the decision

• Evidence considered

What Happens If My Client Gives Me a Blanket IR35 Assessment?

This is common, especially with risk-averse clients.

When Blanket Assessments Are Non-Compliant

If the decision doesn’t consider your actual circumstances, it’s invalid.

How to Challenge It

Politely. With evidence. And ideally with professional backing.

Rights Contractors Have

You can dispute decisions. Clients must respond within 45 days.

What Is a Status Determination Statement (SDS)?

Think of it as the client’s official IR35 conclusion.

What an SDS Must Include

• Inside or outside IR35

• Detailed reasoning

How Contractors Should Use an SDS

Review it. Challenge if wrong. Keep it for your records.

When an SDS Is Invalid

If it lacks reasoning, is generic, or is blanket-issued — it’s invalid.

Can I Appeal an IR35 Decision Made by My Client?

Yes.

Client Dispute Process

Submit your evidence. Wait for their written response.

Typical Evidence

• Contract

• Working practices

• Substitution rights

• Project scope

Timelines

Clients must reply within 45 days.

What Happens If I Work Through Multiple Clients — Can Some Assignments Be Inside and Others Outside IR35?

Absolutely.

IR35 is assessed per engagement, not per contractor.

How to Manage Mixed-Status Contracts

Keep excellent records. Ensure payroll is handled correctly for inside IR35 income.

Accounting and Payroll Implications

You may need:

• Umbrella payroll

• PAYE

• Limited company invoicing

Recordkeeping

HMRC will expect clear separation.

What Are the Penalties for Getting IR35 Wrong?

It’s not pretty.

Financial Penalties

• Back taxes

• Interest

• Penalties

Reasonable Care

If you demonstrate reasonable care (e.g., using an accountant), penalties drop significantly.

Does IR35 Apply If I Work Via an Umbrella Company?

No.

The umbrella handles PAYE, so IR35 isn’t relevant.

But…

Risks of Disguised Remuneration Schemes

Avoid any umbrella offering:

• Loans

• Offshore schemes

• 80–90% take-home pay

You will get caught.

How Does IR35 Affect Take-Home Pay?

Inside IR35 means:

• PAYE

• Employee NI

• Employer NI

• Pension contributions

Outside IR35 means:

• Salary + dividends

• Allowable expenses

• More control

What Should I Pay Myself — Salary vs Dividends?

Most contractors use:

• A tax-efficient director’s salary

• Dividends on top

As long as the company has profit and sufficient reserves.

How Much Corporation Tax Will My Limited Company Pay?

Depends on your profits.

Allowable deductions reduce your taxable income:

• Equipment

• Software

• Accountancy fees

• Travel (if allowable)

• Pension contributions

Can My Limited Company Claim the Flat Rate VAT Scheme?

Yes — if eligible.

Great for contractors who have low expenses.

How Do Director’s Loans Work?

Your Director’s Loan Account (DLA) tracks money you take out of or put into the company.

If overdrawn, you may owe Section 455 tax.

What Happens If I Take a Permanent Role?

You can:

• Pause the company

• Keep it active

• Close it

Each option has different tax implications.

How Do I Close Down (Liquidate) My Contractor Company?

Two main ways:

• Strike-off

• Members Voluntary Liquidation (MVL)

MVLs can unlock Business Asset Disposal Relief, giving you a 10% tax rate.

What Software Should I Use for Contractor Bookkeeping?

I recommend:

• QuickBooks

• Xero

• FreeAgent (great for contractors using certain banks)

Use apps like:

• Dext

• Hubdoc

Can I Claim Home Office Expenses as an IT Contractor?

Yes.

Options include:

• HMRC’s flat rate

• Actual costs

• Broadband/mobile allocations

But if inside IR35, rules change.

Can I Claim Training and Certification Costs?

If the training refreshes existing skills, yes.

If it teaches brand new skills, maybe not.

Are Travel and Subsistence Allowable Under IR35?

Outside IR35: often yes.

Inside IR35: typically no.

Mileage Rules and the 24-Month Rule

If you're at a location for more than 24 months, travel stops being allowable.

This catches people out.

Can Contractors Claim Entertainment or Subsistence?

• Meals during business travel: yes

• Entertaining clients: no

• Staff entertainment (including yourself): limited but allowed

VAT Registration for Contractors

If you hit the VAT threshold (currently £90,000), you must register.

Voluntary registration can also be beneficial.

Should I Choose Flat Rate or Standard VAT?

Flat Rate is great for low-cost traders.

Standard VAT is better if you buy a lot of equipment.

Can I Reclaim VAT on Equipment?

Yes — unless you're on Flat Rate, in which case only capital assets over £2,000 qualify.

Do Contractors Need an Accountant?

In my honest (and biased) opinion: yes.

And not because you can’t do it yourself.

The real value is:

• Protecting yourself from HMRC

• Staying compliant with IR35

• Saving tax legally

• Avoiding costly mistakes

I’ve seen accountants save contractors £10,000+ simply by structuring their pay correctly.

How Do IR35 Specialists Assess a Contract?

They look at:

• Substitution

• Control

• MOO

• Working practices

They recommend changes that strengthen your position.

How Can I Maximise Take-Home Pay?

• Optimise your salary/dividend mix

• Claim allowable expenses

• Plan pension contributions

• Stay away from dodgy schemes

Should I Use a Limited Company, Umbrella Company, or PAYE?

Limited company contractors generally keep the most.

Umbrellas offer simplicity.

PAYE contracts can work for short-term engagements.

Managing Pensions as a Contractor

You can contribute via:

• Your limited company (corporation tax relief)

• Personally (income tax relief)

Both options are tax-efficient.

What Should I Do If a Client Wants Me to Move to an Umbrella Company?

It happens more often now.

Understand why.

Check the numbers.

Negotiate if possible.

Avoid umbrellas with “loan-based” schemes.

Final Thoughts

Contracting gives you freedom, income potential, and flexibility that traditional employment can’t match. But it also brings responsibility. Once you understand the rules — and surround yourself with the right advisors — you can focus on what you do best while running a compliant, efficient, profitable business.

If you want help navigating any of the areas above, get in touch. You don’t have to manage this alone.

Accounting for IT contractors is complex — but with the right support, it becomes structured, predictable, and surprisingly rewarding.

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