How limited company contractor tax works

Operating through a personal service company (PSC) means tax is applied in layers. The company pays corporation tax on its profits. The director then pays personal tax on whatever is extracted, whether as salary, dividends or pension contributions. The total tax bill depends on how those layers interact, which is why extraction strategy matters at least as much as keeping costs down.

This guide covers each layer in turn: corporation tax rates and the marginal relief band, how dividend taxation works in 2026/27 following the Finance Act 2026 changes, NIC for a director's payroll, salary and dividend extraction strategy (including the Employment Allowance fork), and the section 455 charge on director's loans. Where figures have changed for 2026/27, those changes are flagged explicitly.

For context on how IR35 affects which rules apply to your income, the guide at what is IR35 covers Chapter 8 versus Chapter 10, and who is responsible for determining status under each.

Corporation tax: rates, bands and marginal relief (2026/27)

A UK limited company pays corporation tax on its taxable profits. For financial year 2026 (which for most companies means accounting periods ending in the year to 31 March 2027), the rates are:

  • 19% where augmented profits are £50,000 or below (the small profits rate)
  • 25% where augmented profits exceed £250,000 (the main rate)
  • Marginal relief between £50,000 and £250,000, using the standard fraction 3/200

Finance Act 2026 made no change to these rates. They are the same as for financial year 2025. A contractor who has been planning around 19% and 25% can continue to do so.

What marginal relief means in practice

In the band between £50,000 and £250,000, the company pays the 25% main rate, then claims marginal relief calculated as: 3/200 multiplied by (£250,000 minus augmented profits). This produces an effective marginal rate of around 26.5% on each additional pound of profit in that range. The effective rate climbs through the band and settles at 25% at the top.

For a contractor with, say, £80,000 of company profits, the first £50,000 is not taxed at 19% under marginal relief; marginal relief works by reducing the main-rate charge, not by applying 19% to a slice. The practical result is that £80,000 of profit costs more CT per pound than £50,000, and the contractor pays closer to 22% to 23% overall, not a simple blend of 19% and 25%.

This has a direct bearing on the pension lever: a well-timed employer pension contribution can bring augmented profits below £50,000 and push the effective rate back to 19%.

Associated companies: the trap that shrinks the bands

The £50,000 small-profits limit and the £250,000 main-rate limit are divided by the number of associated companies (CTA 2010 ss.18E onward). Two companies are associated where one controls the other, or both are under common control.

A contractor with two PSCs, or a PSC and a connected spouse company, must divide both limits by two. Each company then has a small-profits limit of £25,000 and a main-rate threshold of £125,000. Profits that looked comfortably within the 19% band for a single company now fall into the marginal zone. This is easy to overlook when a spouse starts a second limited company, and the tax cost of getting it wrong can be significant.

The association test does not require formal cross-ownership; shared control (through a common director, shareholder or family relationship) can be enough. If there is any connected company in the picture, model the effect on the limits before assuming the full bands apply.

Dividend taxation in 2026/27: the Finance Act 2026 changes

Finance Act 2026 section 4 raised the dividend ordinary and upper rates from 6 April 2026. For 2026/27, the rates are:

  • Ordinary rate: 10.75% (up from 8.75% in 2025/26), applying to dividends in the basic-rate band
  • Upper rate: 35.75% (up from 33.75%), applying to dividends in the higher-rate band
  • Additional rate: 39.35% (unchanged), applying to dividends above £125,140

The dividend allowance is £500 for 2026/27 (unchanged). Dividends within this allowance carry no tax charge.

Dividends are taxed after non-savings income (including salary) and savings income. They sit at the top of the income stack. The personal allowance is £12,570 and the higher-rate threshold is £50,270, both frozen to April 2031 following the November 2025 Budget extension. Fiscal drag (more income pulled into higher bands as earnings grow while thresholds stay fixed) is now a concrete planning issue for every PSC director through to 2030/31.

What the 2026/27 rate rise means for extraction

The 2-percentage-point increase in the ordinary and upper dividend rates makes salary/dividend extraction slightly less advantageous compared with 2025/26. A director taking £30,000 in dividends within the basic-rate band now pays £450 more in tax than the year before (£30,000 at 2% extra, less the £500 allowance effect). On a full extraction of £80,000 in dividends straddling the higher-rate threshold, the additional cost is larger.

This does not mean dividends are no longer efficient. Dividends carry no NIC, and the overall combined corporation-tax-plus-dividend-tax burden for a basic-rate extraction remains well below an equivalent salary. But it does mean the gap between the two routes is narrower in 2026/27, and the pension contribution route (which avoids dividend tax entirely) becomes relatively more attractive.

See the guide on contractor pension employer contributions for the full picture on using pensions as the primary extraction route.

The £100,000 personal allowance taper

Where a director's adjusted net income exceeds £100,000, the personal allowance is tapered at £1 for every £2 above that threshold, disappearing entirely at £125,140. This creates an effective 60% income tax rate on earnings between £100,000 and £125,140 (40% income tax plus the loss of allowance). Dividends that push total income above £100,000 trigger this taper even if the dividends themselves would be taxed at the upper rate.

For PSC directors with profits in this range, timing of dividend declarations and the use of employer pension contributions (which reduce adjusted net income and can restore the personal allowance) are critical tools.

National Insurance for a PSC director in 2026/27

National Insurance rules for a limited company director differ from both an employee and a self-employed person, and the 2026/27 rates represent a substantial change from the pre-April-2025 position.

Employer (secondary) Class 1 NIC

The company pays employer NIC at 15% on any director's salary above the secondary threshold of £5,000. This rate and threshold were set from April 2025 and carry into 2026/27 (the rate rose from 13.8% and the threshold fell from £9,100 to £5,000 at that point). The lower earnings limit (LEL) is £6,708 for 2026/27, which preserves the director's National Insurance record for state pension and contributory benefits even where very little NIC is actually paid.

Employee (primary) Class 1 NIC

The director pays employee NIC at 8% on earnings between the primary threshold (£12,570) and the upper earnings limit (£50,270), then 2% above the UEL. Below £12,570, no employee NIC is due. This means a director taking a salary at or below £12,570 pays no employee NIC on that salary.

The Employment Allowance and the single-director exclusion

The Employment Allowance (£10,500 for 2026/27) offsets an employer's secondary Class 1 NIC. A company with sufficient employer NIC could, in theory, pay a salary up to around £75,000 before the allowance runs out. But a company whose only employee is a single director cannot claim the Employment Allowance. This exclusion is the central constraint in the salary optimisation calculation for most PSC contractors.

Once a second genuine employee joins the payroll (including a working spouse), the Employment Allowance becomes available, and the optimal salary level changes entirely. See the next section.

Extraction strategy: salary, dividends and the Employment Allowance fork

The right extraction mix for a PSC director depends on three things: Employment Allowance eligibility, whether other income is using the personal allowance, and the company's corporation tax marginal rate. There is no single universally optimal salary. What follows is the framework; the right number for any individual needs to be modelled against their specific facts.

Scenario A: single-director PSC, no Employment Allowance

For a director whose only employment is through their own PSC and who has no other employees, the Employment Allowance is unavailable. The salary targets for 2026/27 are:

  • £5,000 (secondary threshold): no employer NIC on the salary. But this is below the LEL of £6,708, so it does not generate a qualifying NI year for state pension purposes.
  • £6,708 (lower earnings limit): this is the typical target for a director who wants to maintain their NI record. The company pays employer NIC at 15% on the slice between £5,000 and £6,708 (that is, 15% of £1,708 = £256.20). The director pays no employee NIC (the primary threshold is £12,570). The salary is deductible against corporation tax at 19% to 26.5%, which offsets some of the employer NIC cost. A qualifying NI year is secured.
  • £12,570 (personal allowance / primary threshold): even without the Employment Allowance, there is a case for this salary at the right marginal CT rate. The extra salary above £6,708 saves CT (at 19% to 26.5%) and uses the personal allowance, while the employer NIC on the additional slice (15% of £7,570 = £1,135.50) and the employee NIC cost both need to be weighed. At a 19% CT rate, the arithmetic often favours staying at the LEL. At a 25% or 26.5% marginal CT rate, taking the full personal allowance can give a modest net benefit. Model it; do not assume either answer.

Scenario B: company qualifies for the Employment Allowance

Where the company has at least one other genuine employee on the payroll (such as a working spouse), the Employment Allowance offsets up to £10,500 of employer NIC. In this case, the employer NIC on a salary of £12,570 is largely or entirely covered by the allowance. The salary is fully deductible against CT, and the director pays no employee NIC below the primary threshold. Salary at £12,570 is almost always the right starting point in this scenario, though any salary above that point triggers employee NIC at 8%.

Taking dividends efficiently

After salary, remaining distributable profits can be paid as dividends. For 2026/27, a director taking salary at £6,708 has used approximately £6,708 of the personal allowance, leaving around £5,862 of the allowance free. Dividends within that free allowance are effectively tax-free (though within the £500 dividend allowance first). Dividends above the personal allowance up to £50,270 are taxed at the ordinary rate of 10.75%.

The key discipline is to keep track of total income across all sources (salary, dividends, savings income) to avoid accidentally crossing the £50,270 higher-rate threshold or the £100,000 personal-allowance taper without planning for it.

For a deeper view of how to use pension carry-forward to manage larger extraction in a high-profit year, see contractor pension carry-forward.

Employer pension contributions: the biggest lever

The employer pension contribution sits above salary and dividends as the most tax-efficient extraction mechanism for most PSC directors. The company pays the contribution directly into the director's pension scheme. It is deductible against corporation tax, carries no employer or employee NIC, and is not taxable on the director as income when paid in (subject to the annual allowance).

The annual allowance is £60,000 for 2026/27 across all contributions, employer and personal combined. Unused allowance from the previous three tax years can be carried forward, and the company can make a single large contribution in a high-profit year without breaching the limit if earlier years had spare headroom. Crucially, the employer contribution is not capped by the director's salary (unlike a personal contribution, which is limited to 100% of relevant UK earnings). A director taking a salary of £6,708 can still receive an employer pension contribution of £60,000 (or more, using carry-forward), making this route available regardless of the low salary strategy.

The interaction with the marginal relief band is significant: a £30,000 employer pension contribution that takes augmented profits from £80,000 to £50,000 saves 26.5% on the £30,000 (around £7,950 in CT), plus avoids the dividend rate and any personal income tax on that extraction.

The taper of the annual allowance begins where threshold income exceeds £200,000 and adjusted income exceeds £260,000, reducing the allowance by £1 for every £2 above £260,000 to a minimum of £10,000. The money purchase annual allowance (MPAA) of £10,000 applies if the director has previously accessed a defined-contribution pension flexibly, and carry-forward is lost for DC contributions once triggered.

Section 455: loans to participators and the director's loan account

A PSC is a close company, and drawings taken from the company that are not salary, dividend or expense reimbursement go through the director's loan account (DLA). An overdrawn DLA at the end of an accounting period triggers a corporation tax charge under CTA 2010 section 455.

The rate: two bands by date

The section 455 rate tracks the dividend upper rate. Finance Act 2026 raised the dividend upper rate from 6 April 2026, so there are now two bands:

  • 33.75% on loans made before 6 April 2026
  • 35.75% on loans made on or after 6 April 2026

A loan taken in March 2026 is charged at 33.75%. A loan taken in May 2026 is charged at 35.75%. Where a director's loan account builds up over several years, the amount charged at each rate depends on when each advance was made.

When the charge is paid

The section 455 charge is payable 9 months and 1 day after the end of the accounting period in which the loan is outstanding. For a company with a 31 March year-end, a loan overdrawn on 31 March 2027 produces a s.455 charge due on 1 January 2028.

Repaying the loan and section 458 relief

The section 455 charge is temporary, not a permanent tax on the loan. Once the loan is repaid, released or written off, the company claims section 458 relief to recover the tax paid. However, that relief is itself deferred: HMRC repays it 9 months and 1 day after the end of the accounting period in which the repayment occurs. A loan repaid in, say, April 2027 does not generate a cash repayment from HMRC until January 2028 at the earliest.

This deferral means an overdrawn loan account ties up a meaningful amount of cash. On a £50,000 loan, the section 455 charge at 35.75% is £17,875. That sum is outstanding for the life of the loan plus the deferral period. Paying back the loan by clearing it as a formal salary or dividend before the period-end avoids the charge entirely.

The £10,000 beneficial loan threshold

A director's loan that exceeds £10,000 at any point during the tax year also creates a beneficial loan benefit in kind under ITEPA 2003 sections 173 to 191, unless the director pays interest to the company at HMRC's official rate. The benefit is taxed as employment income. This is separate from the section 455 charge: both can apply simultaneously. Keeping the DLA below £10,000 at all times avoids the benefit-in-kind issue, though the section 455 charge still bites if the account is overdrawn at the period-end even if the balance is small.

Avoiding section 455 problems

The cleanest way to avoid section 455 is to draw money from the company only as salary, expense reimbursement or formally declared dividends. Where drawings run ahead of declared salary and dividends (common in early trading when income is irregular), a year-end review should identify any overdrawn balance and clear it by declaring a dividend (out of available retained profits) or a salary before the year closes. An accountant who monitors the DLA throughout the year is worth the cost.

The interaction between CT bands, dividends and extraction planning

These rules do not operate in isolation. The CT rate the company pays, the dividend rate the director pays, and the NIC avoided through a low salary all interact. A worked example illustrates this for a 2026/27 PSC with a single director, no Employment Allowance, and £100,000 of contract revenue (net of VAT) after direct costs:

  • Director takes salary at the LEL: £6,708. Employer NIC: £256.20 (15% on £1,708). The salary and NIC together are a CT-deductible expense.
  • Taxable company profits: £100,000 minus £6,708 salary minus £256.20 NIC minus other deductible running costs. Say £88,000 after those deductions.
  • CT at the marginal rate: £88,000 falls between £50,000 and £250,000. CT is 25% of £88,000 (£22,000) less marginal relief of £2,430 (3/200 of the gap to £250,000), so roughly £19,570, an effective rate of about 22.2%, leaving around £68,430 after tax in the company.
  • Director declares a dividend of £67,760. Personal tax: the first £12,570 minus the £6,708 salary (approximately £5,862) is covered by the personal allowance. The £500 dividend allowance applies next. The remaining balance below £50,270 is taxed at 10.75%. The slice above £50,270 (if any) at 35.75%.

Inserting a £20,000 employer pension contribution into this example reduces company profits by £20,000 before CT, saving CT at roughly 26.5% (£5,300) and avoiding dividend tax on that £20,000 entirely. The total tax saving relative to paying the £20,000 as a dividend is material, which is why every extraction conversation should model the pension option first.

Income tax bands and the fiscal drag effect

The personal allowance (£12,570) and higher-rate threshold (£50,270) have been frozen since April 2021. The November 2025 Budget extended that freeze to April 2031. For a contractor whose income is growing (or whose contract rate is rising with inflation), this freeze means that an increasing share of income will be taxed at the higher rate even without a real-terms earnings increase.

For 2026/27, total income (salary plus dividends) above £50,270 is taxed at the higher income tax rate and at the upper dividend rate of 35.75%. A contractor who was comfortably within the basic-rate band two years ago may now be straddling the threshold. Building a plan that accounts for the static thresholds through to 2031, rather than treating each year in isolation, produces materially better outcomes.

If total income is approaching £100,000, the personal allowance taper creates an even sharper incentive to either cap extraction below that level or use an employer pension contribution to reduce adjusted net income and restore the allowance. Every £2 of adjusted income above £100,000 costs £1 of allowance, adding an effective 20p in the pound surcharge (at the basic rate) or 40p (at the higher rate) on top of the normal liability.

Keeping the tax picture together across the year

A PSC director files both a corporation tax return (CT600) for the company and a personal Self Assessment return for their salary and dividends. The key year-end disciplines are:

  1. Review the director's loan account before the period-end. Any overdrawn balance needs to be cleared by a salary or dividend declaration, or the section 455 charge will apply at 35.75% for the current year.
  2. Confirm the dividend position. Dividends must be formally declared (board minute for a sole-director company) and paid from distributable reserves. A dividend that exceeds available retained profits is unlawful and may be recharacterised as a salary or loan.
  3. Check the pension allowance. If there is unused allowance from the previous three years, a larger employer contribution before the year-end can reduce CT and build retirement provision simultaneously.
  4. Model the total personal income position before declaring the final dividend for the year. The interaction of salary, dividends, the personal allowance, the higher-rate threshold and the £100,000 taper can produce unexpected tax bills if the last dividend takes total income over a cliff edge.

For contractors whose work is assessed as inside IR35 for one or more engagements, the tax picture changes substantially; the salary/dividend flexibility largely falls away for the inside-IR35 income. The guide on the consequences of being inside IR35 covers what that means in practice.

Associated companies: a checklist

Given the potential impact of the associated-companies rule on the CT bands, it is worth running through the checklist before assuming the full £50,000 / £250,000 limits apply:

  • Does the director control any other company (through shareholding, directorship or both)?
  • Does the director's spouse, civil partner or close associate control another company?
  • Are there other companies in which the director or connected persons hold shares or voting rights that, combined, amount to control?

If any of these applies, take professional advice on the association before filing. The bands may be halved, or reduced further, with a significant effect on the CT bill. For specialist contractor accounting that covers this properly, see our services page or contact us to discuss your structure.

What to do next

The tax position for a limited company contractor in 2026/27 is more complex than in previous years, primarily because the Finance Act 2026 dividend rate increase, the continued threshold freeze, and the employer NIC changes from April 2025 all interact. Getting the extraction strategy right (salary level, dividend timing, pension contributions and loan account management) can make a meaningful difference to the annual tax bill.

If you would like a review of your current structure and extraction strategy for 2026/27, the team at Contractor Tax Accountants works exclusively with limited company contractors and PSC directors. You can request a call or check your IR35 status as a starting point. We also work with contractors across a range of sectors; if you operate in a specialist field, see whether your sector is covered at /for/it-contractors or the other sector pages.