Limited v Umbrella

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by Dolan Contractor Group

When you work as a freelancer, contractor or consultant, one of the fundamental questions you need to address is how to get paid. You won't be on any client payrolls, so you'll need to make your own arrangements. The main options for you to consider are to go self-employed, set up a limited company or work via an umbrella company. Going self-employed means trading completely independently and paying standard income tax rates. In most professions, people prefer to choose one of the other options for the preferential tax rates and protection of personal assets, so we will focus on them.

Limited companies

A limited company is a legal entity that you conduct your business through, either as director or shareholder. As it's a legal entity that is separate from yourself, it has its own bank account and assets. Any contracts you work on are between the company and your client, so any profits or losses belong to the company. The use of the word 'limited' stems from the limited liability concept - this means that the company owner can't be held personally liable for debts or losses the business incurs. If things go badly wrong, creditors can only make claims on the assets of the limited company, but not your own personal assets.

Setting up a limited company and registering it with Companies House incurs a small fee, and there are various reporting requirements. Accounts have to be submitted every year alongside several other administrative documents. There are also strict deadlines for paying Corporation Tax, which currently stands at 20% of company profits (minus expenses).

Choosing this option is the most tax-efficient way to conduct business. You can pay yourself a salary and dividends to enjoy the tax-free allowances of each, make pension contributions through the company and leave funds in the business to pay yourself in future years. By working with a specialist contractor accountant, you can get quality advice on your best options and have administration handled effectively.

The administrative burden is the disadvantage of the limited company. Though a contractor accountant will be able to take some of this strain, you will still need to keep track of income and expenses, including evidence like receipts and invoices. You should also be aware that the tax benefits of limited companies disappear if you fall within the IR35 Intermediaries Legislation. If your personal working arrangements place you on the wrong side of IR35, you'll be compelled to make tax and National Insurance payments at the same rate as an employee, regardless of the limited company structure. If this is the case for you, the umbrella company option might be worth considering.

Umbrella Companies

An umbrella company is an entity that acts as an employer for contractors with temporary contracts. This typically involves those working via a recruitment agency and serves as a single employer through multiple contracts. All contracts are between clients and your umbrella company, which pays you a wage as an employee through a formal PAYE system. Contractors sign a full employment contract with an umbrella company, which means they are entitled to the full range of statutory employment benefits, which includes:

  • Statutory Sick Pay (SSP)
  • Statutory Paternity/Maternity Pay (SPP/SMP)
  • Annual leave pay
  • A pension scheme

Many umbrella companies also choose to offer extra employment benefits that are not legal requirements, including private medical cover, insurance, access to welfare services like counselling, and reward packages. Since employees of umbrella companies receive payment through a PAYE system, there are no further reporting requirements. Just as with a permanent employee, tax is deducted centrally and declared to HMRC with every wage packet.

Being paid through an umbrella company involves the least administrative burden. The company will invoice clients for your work on a predetermined timescale, and everything will be processed through PAYE. The most you'll need to do is submit a weekly timesheet. Umbrella companies are also good for short-term contracts, or if you're uncertain about the length of your contract. A limited company has to be closed down if it is no longer required, but with an umbrella company you can simply end your employment if their services are no longer required. You will then be issued with a P45 that can be taken to your next employer.

Which is the better option?

The answer to this really depends on your own circumstances. Whichever option you choose, it's worth noting that you can never be certain what will happen in the future, so you should reassess your choices periodically to ensure you are always following the best path. There are umbrella companies that will allow you to switch between limited and umbrella company employment as needed, and they may be worth exploring for you. Be sure to ascertain where you fall with regards to IR35 before making a decision.

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