Background – Identifying the Big Issue
At Freestyle Accounting we deal with a range of businesses including start-ups where the proprietors have no previous experience of being in business on their own account. One of the first conversations we will have with such clients is about the form of trading entity that is most appropriate for their business venture.
If it is a genuine one-man band, perhaps operating as a sole trader (at least in the earlier years) is the best vehicle – it may be less tax efficient than setting up a limited company, but there is also less red tape and you’ll pay less in accountancy fees! Where there are two or more proprietors involved, a partnership may be the best way to work together – indeed in some professions that may be a requirement. The third option is to set up a limited company and there are a number of good reasons for doing so; the tax benefits we have already indicated, but there are also some more strong commercial arguments in favour of incorporating.
Firstly, your liability is limited, which may be important dependent on the nature of the goods and services being provided, or indeed the risk being undertaken within the market that your business will be trading. Secondly – and for the contractor or freelancer this is the critical point – the market may dictate to you that the only way to win business is to operate as a limited company contractor.
Client Companies don’t want additional staff
Many companies prefer not to employ additional staff if they can avoid it. Possibly there is head office pressure on headcount (an agency fee for the use of a contractor will go through purchases as a service bought-in, rather than through the payroll) and it will often be the case that if the work is for a specific project, there will be no further work for the individual once the project is completed. What will certainly be seen as a cost of employment by the company is not only the benefits package (pension, private healthcare, company car, holiday pay etc, etc) over and above the salary that must be offered to an employee, but there is also the management time and resources in trying to meet an employee’s career aspirations.
In order to avoid all of these costs (and headaches), clients are happy to pay a premium either directly to a contractor, or more often via an agency, to bring in resources as and when they are needed. However, they want to ensure that the contractor is not deemed to be an employee of theirs and so they do not want to engage the individual directly, what they want is to engage a limited company which is essentially an intermediary between them and the individual.
Why? Because you cannot ‘employ’ a limited company, whereas a sole trader could be reclassified for tax purposes as a deemed employee (to understand how, please see our article on determining IR35 status). The only organisation that could be deemed the employer of this reclassified individual is the End Client and HMRC will argue that they have failed to operate Pay as You Earn (PAYE). Suddenly the End Client will have to pay over tax and National Insurance Contributions (both employer and employee) not correctly deducted. Furthermore, HMRC will be adding interest to the tax bill and will want to levy a monetary penalty for non-payment.
So for the End Client putting a limited company between themselves and the contractor is critical and in many cases the appointment of an agency to find the resources and then to engage the contractor is the solution. However, for you as a contractor, this is not the end of the story….read on in an introduction to contracting – part 2.