Without good, comprehensive information to help you to make an informed decision, this question could cause the first-time Contractor many a sleepless night. But the truth is, you’ve done the hard part; you’ve made the decision to leave the security of your employer’s nest to join the more lucrative but potentially more challenging “big wide world” of Contracting. You may have had input from family, friends and colleagues but ultimately only YOU knew whether Contracting would be right for you.
Fortunately, once you’ve read this article and are armed with ALL the necessary information, the decision on whether to go Umbrella or Limited Company should be an obvious choice for your scenario.
This comprehensive article is all about making sure that you are armed with absolutely everything you need to know to answer the ‘Limited Company vs Umbrella Company’ question for YOU.
(If you are in a rush though, drop down to the ‘At a Glance’ section for a quick summary or click to watch the video below)
Often the answer lies in your motivation for deciding to become a Contractor, but we’ll come back to that in a moment. First of all let’s consider the fundamental differences between the two.
Looking at the Ltd Company structure - by setting up and running your own limited Company, you become a director and shareholder and therefore have complete control over the running of your Company, its bank accounts and financial affairs. You can take a small salary then draw the rest of what you decide to pay yourself in the form of dividends, from your Company, that are not subject to National Insurance (NI) contributions.
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The alternative to setting up your own limited company is to use the services of an umbrella company. An Umbrella Company is essentially an invoicing vehicle – they contract directly with your client or agency and employ you on a PAYE basis. They are responsible for invoicing, chasing payments from clients / agencies and calculating tax and national insurance (NI) contributions.
Contracting through your own Limited Company will typically allow you to take home approximately 75-90% of your earnings, depending on your contract expenses and individual circumstances. See the ‘Income Illustration Examples’ below.
Provided your contract falls outside of IR35 legislation (see opposite for an explanation of IR35), you may pay yourself a small salary but then draw the rest of what you decide to pay yourself in the form of dividends from the company that are not subject to National Insurance (NI) contributions.
This, together with the ability to claim back a wider range of contract expenses (e.g. accountancy fees, training, equipment & software costs) and access to a VAT scheme known as the flat rate scheme, makes the limited company the most tax efficient way of working and in turn the most attractive option for maximising your income.
Contracting through an Umbrella services Company would give you take home pay, more in the region of 60-65% as it offers little benefit for individual Contractors in terms of reducing tax liabilities. Additionally Umbrella companies’ service fees can be up to 9% of the value of your contract, so this needs to be considered when reviewing which trading structure is most suitable for you.
IR35 Legislation was introduced by the Government in order to stop contractors providing their services through a limited company to avoid tax and National Insurance contributions. IR35 effectively seeks to determine what the relationship would be if you were employed directly by the end client. For detailed information on IR35 legislation please download our Free Guide.
It’s worth noting that if you are employed by an umbrella company, IR35 legislation does not apply.
As a Director of your own Limited Company, you are responsible for all of your own paperwork including invoicing, expenses, bookkeeping and ensuring that your accounts are in order. If, however, you subscribe to an ‘all-inclusive’ service through a good quality accountant, a lot of this paperwork will be managed for you.
Contracting through an Umbrella Company is ideal for those who don’t want the hassle of dealing with any paperwork. You simply submit your timesheet and expenses to the Umbrella Company and they will do the rest for you – invoicing, chasing payment and calculating tax and national insurance (NI) contributions.
With Limited Company contracting, as a Company Director, you are responsible for invoicing your client and managing the Company bank account. The client will pay your Company direct and you can then pay yourself.
If you are contracting through an Umbrella Company, the Company will invoice the client on your behalf. The Client will pay the Umbrella Company and the Umbrella Company in turn pays you.
If the Umbrella Company ceases to operate, however, you won’t get paid! Likewise, if there’s a delay in the Umbrella Company getting paid, then you too will have to wait for your money.
Contracting through a Limited Company is most suitable if you earn more than £15 per hour, plan to be contracting for more than 6 months and are happy to manage the Company administration.
Umbrella Companies, however, are more suited to those Contractors who will be earning £15 per hour or less, are on shorter term contracts (generally less than 6 months) and don’t want to manage any of the paperwork.
So, which trading structure should I choose? Limited or Umbrella Company?
This brings us back to the point about the answer being found in your motivation to become a Contractor in the first place. The vast majority of Contractors leave employment and join the world of contracting in order to increase their net income; contracting rather than employment gives the opportunity for greater earning potential for the same number of hours worked, but also potentially the ability to keep more of what you earn.
Therefore, providing you employ the services of a good accountant offering an all-inclusive accountancy package to minimise your administrative duties, running your own limited Company is the most favourable trading structure for most Contractors due to the higher potential take home pay of between 75-90% of your earnings.
The exceptions are those Contractors who are only intending to contract for a short period of time, those earning less than £25k per annum, those for whom the majority of their contracts will fall inside IR35, and to an extent those who are new to contracting and still not entirely sure whether or not contracting is really going to be for them in the long term.
The Umbrella services Company is sometimes chosen by Contractors who want to avoid the administrative responsibilities associated with running your own limited Company. However, the truth of the matter is that there are now many good accountancy firms offering affordable all-inclusive packages, where they will take care of all but the most minimal of administrative duties for you when running your own limited Company. Good “all inclusive” packages include the use of an online system that you, the Contractor, can use to further simplify what’s required of you.
However, if you only intend to contract for a short period of time (i.e. 3 months or less) then the Umbrella option would definitely suit you well because of the administration and cost involved in opening and closing a Company. It is also worth noting that many Umbrella companies insist on either a minimum level of charging or a minimum time for which you must pay for their services, so be sure to check this when making your choice of provider.
In addition, accountancy fees for running a limited Company compare favourably with Umbrella Company service charges, making the avoidance of administration a less credible argument for the Umbrella route over setting up your own limited Company.
Take a look at the infographic provided below to discover which trading structure is most suitable for you. We have also included income illustrations for Contractors with daily rates of £300 and £500 per day operating through their own limited Company versus using the services of an Umbrella Company. If money is your motivator then the figures speak for themselves.
Let us prepare an individually tailored income illustration for you. Simply complete the enquiry form above and we will provide you with an illustration comparing your take home pay for both trading options!
Contract Value Retained£57, 221
Contract Percentage Retained*83%
Contract Value Retained£64, 500
Contract Percentage Retained56%
Contract Value Retained£90, 701
Contract Percentage Retained*79%
* Your personal income percentage will depend on a number of factors including the amount of expenses you incur.
It is vitally important that you do your research and ensure that you choose a reputable service provider for your chosen route. If you are setting up a limited Company then make sure that the accountancy firm you choose use fully qualified accountants.
It’s always worth confirming what tax or accountancy qualifications their firm holds. The Contracting industry is awash with Accountancy firm that are unqualified, and more importantly, unregulated.
Remember to clarify at the outset exactly what is included in their all-inclusive package and any additional costs that may be incurred. You should also check whether there is a minimum charge/minimum time period for which you need to employ their services.
Hopefully this article has provided you with some insight as to the most suitable trading option for you and saved a few sleepless nights. However, should you have any further questions or would simply like a free “no obligation” opportunity to talk through your own particular scenario before finalising your choice, please do not hesitate to call one of our dedicated Advisors at Freestyle Accounting on 0800 954 2101 or complete the form opposite.
Best of luck with your Contracting endeavours!
The team at Freestyle Accounting
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