If you’re a contractor in the private sector, you can choose to be your own limited company or through an umbrella company. We look at the differences and see which one is better for your needs.
What is a Limited Company?
A limited company is a structure that makes the company a legal ‘person’. It is separate from its owners, meaning it can enter into contracts in its own name and is responsible for its own actions, finances and liabilities.
Benefits of a Limited Company
Perhaps the most significant advantage is the tax benefits. You can pay yourself a lower salary and withdraw the remainder in the form of dividends. This is tax efficient as dividends are not subject to national insurance contributions.
Company directors also have a great deal of flexibility over when to take income which provides further tax relief.
As a limited company has limited liability status, the owners will not be personally liable for any financial losses made by the business. This also provides added protection.
What is an Umbrella Company?
A PAYE umbrella company is a limited company that acts as an employer to contractors. They sign a contract with a recruitment agency on behalf of the working contractor.
The umbrella company provides a payroll service for the contractors. They also pay them a salary based on timesheets and after-tax deductions. You are still able to reclaim the cost of any expenses incurred in the course of ordinary business.
Below is a table outlining the advantages and disadvantages of using either structure.
|Tax-efficient, as mentioned above||Entire salary taxed via PAYE, little opportunity for tax planning|
|Generally, not recommended for contracts paying below £15/hr||Recommended for lower-paid contracts|
|Pay a monthly fee to an accountant||Pay a monthly fee to umbrella company (usually lower)|
|Monthly admin, hence, need for accountants||Very little admin|
|Director of own company||An employee of an umbrella company|
|Ideal for long term contracts and providing services to multiple clients||Ideal for short term contracts, not for providing services to several clients|
|Requires business bank account||Only need a personal bank account|
|Pay business insurance on your own||Insurance usually covered by umbrella fee|
|You invoice the agency||Submit timesheet to the umbrella company, they invoice the agency|
|Can offset expenses against the company’s tax bill||Reclaiming expenses is restricted|
|You must comply with IR35 rules||IR35 is not relevant|
|Annual tax return for all directors required||Tax return not required unless additional income is earned|
Contractors and IR35
If the IR35 legislation affects your contract work then you may be better off choosing to work for an umbrella company.
IR35 was first introduced in 2000. It aims to ‘clampdown’ on single person limited companies providing professional services to clients whilst remaining as a traditional employee.
During an IR35 check HMRC will review different factors to determine whether you are employed, or self-employed for tax purposes. The main factors include
- Control – is the worker under supervision?
- Substitution – can the worker provide a substitute if they are unavailable?
- Mutual Obligation – is there an expectation of further work once the current work expires?
For more information on IR35 or if you are looking to operate as a limited company contractor, we can help you get started straight away. Get in touch today for more information.