Contractors' Questions: How best to develop software on the side?

Contractor’s Question: I’m a software developer with a limited company that I occasionally use when working with large outfits, but I’m also an employee of a local software firm. 

I want to earn an even higher income but am unsure on doing this via my ‘Ltd,’ as it would land it a higher tax bill. Would I be better off to keep my limited company just for the few existing clients, but obtain new work via an agency on an umbrella or self-employed basis?

Expert’s Answer: Running a limited company alongside permanent employment can be tax-efficient depending on individual circumstances. An additional consideration to the financial implications would be any restrictive covenants contained within your contract of employment. There may not be any in place. But it’s worthwhile checking to be on the safe side. Should there be restrictive covenants, the employer might simply want to be informed of your work outside of their employ. There could be stronger obligations on you, however.

On the presumption that you are already within the higher rate tax band, running additional income through the limited company would then remove this to a lower rate of tax, at least until it is then withdrawn from the company.

Should it be withdrawn by way of dividends-salary, then this is likely to attract higher rate tax but potentially without any national insurance costs, depending on the strategy used. There could be other options available, such as retaining the funds, making use of additional shareholders, pensions or other tax-deductible payments. It all depends on your set-up and requirements.

Other considerations you have as to whether to park the limited company or use it include the running costs of the company; now and in future. Also, any new contracts you seek might require insurances, accountancy and bank charges -- all have costs tied to them which a company can absorb and administer, but you may not be paying these now given that your existing usage of the company is only occasional. These common requirements of taking on new business should all be borne in mind as part of any financial planning exercise. Plus, ensuring that an IR35-friendly contract and working practice are in place for each and every new assignment you take on are also very important.

Overall, it seems it could well be efficient to use your existing company to execute more work, although the umbrella route might be advantageous too. As to the self-employed (sole trader) route, you’d probably struggle to find an agency who’d take you on due to a piece of tax legislation. With many, many variables in play, I’d recommend you sit down with a tax professional to run through the ‘pros and cons’ of the three different routes.

To prepare for the sit down, you could use an online tax calculator to work out your basic figures while factoring in the value of your company’s contracts (existing and potential), costs and tax liabilities. In short, do some rough number work before making any decisions and then get tailored advice before you commit to a strategy that is the most appropriate for you.

The expert was Darren Roberts, head of contractor services at Dynamo Accounts.

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