One of the main tax advantages of contracting through a limited company outside IR35 is the ability to pay yourself a combination of salary and dividends. Getting the split right can save you thousands of pounds per year compared to taking all your income as salary.
The optimal salary level
For the 2025/26 tax year, most contractor accountants recommend a director's salary of £12,570, which is the personal allowance threshold. At this level, you pay no income tax on your salary and minimal National Insurance contributions. Your company can deduct this salary as a business expense, reducing its Corporation Tax liability.
Why not a higher salary?
Salary above the personal allowance attracts both income tax at 20 percent and employee National Insurance at 8 percent, plus employer NI at 13.8 percent. That is a combined tax rate of over 40 percent. Dividends, by contrast, are taxed at 8.75 percent (basic rate), 33.75 percent (higher rate), or 39.35 percent (additional rate), with no National Insurance. The NI saving alone makes dividends more tax-efficient up to the higher rate threshold.
How dividends work
After paying Corporation Tax on your company's profits (currently 25 percent for profits over £250,000, with a small profits rate of 19 percent for profits up to £50,000), the remaining after-tax profit can be distributed as dividends. You receive a £500 annual dividend allowance tax-free. Dividends above this amount are taxed at your marginal rate, but without NI.
Worked example
A contractor billing £500 per day for 220 days generates £110,000 gross revenue. After £12,570 salary, £6,000 expenses, and £2,000 pension contribution, taxable profit is approximately £89,430. Corporation Tax at the marginal rate reduces this to approximately £70,000 available for dividends. The total take-home after dividend tax is approximately £78,000–£82,000 depending on the exact numbers. The same gross income taken entirely as salary through PAYE would yield approximately £65,000–£70,000.