Without comprehensive information to help you to make an informed decision, deciding whether to trade using an umbrella company or a limited company could cause you many a sleepless night. Fortunately, once you’ve read this article you will be armed with all of the information needed to decide whether an umbrella company or a limited company is 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.
(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. However, we will come back to that in a moment. First of all, let’s look at the fundamental differences between the two.
Umbrella Company (Payroll Service)
An umbrella company is essentially an invoicing vehicle for contractors who want to avoid the administration duties normally associated with contracting, namely issuing invoices, chasing payments from clients/agencies, calculating tax and National Insurance (NI) contributions and making payments to their bank account. It’s worth noting that because you are employed by the umbrella company, IR35 legislation does not apply.
Contractors who work through an umbrella service will submit timesheets and expenses (normally online) and then leave the rest up to the umbrella company. They will generate and send invoices to the agency or client, chase payment when it’s due and then upon receipt of payment will calculate your tax and NI and transfer your net pay direct to your bank account.
Whilst previously contractors were able to claim travel and subsistence expenses through an umbrella company, the ability to do this was removed on 6th April 2016 as part of the Chancellor's Autumn Statement on 25th November 2015.
Limited Company (or Personal Service Company)
With a limited company, or a personal service company as it sometimes also known, you will have complete control of the day-to-day running of your company. You will become a director and shareholder, and will have complete control over every aspect of your company including its bank accounts and financial affairs.
Provided your contract falls outside of IR35 (i.e. you're not deemed to be an employee of the client using a limited company as a disguise) you will also be able to draw dividends from the company which are not subject to NI contributions.
Working through your own limited company is often the most tax efficient method of contracting and will allow you to keep more of your income. However, again these tax advantages are wholly dependant on whether your contract falls inside or outside of IR35. Despite this, many contractors decide against starting a limited company because of the day to day administration and the legal requirements all limited companies have to comply with.
Providing an alternative to this though, our Freestyle contractor limited company accountancy service removes the administrative burden of setting up and running a limited company.
As part of this service, everything from company formation, the setting up of your bank account through to invoicing your clients, monthly payroll, annual account preparation and corporation tax returns are all included.
As a contractor, you simply enter your expenses and invoices online and we will handle everything else and provide you with an up to date live position of your company’s financial situation.
For more detailed information on setting up your limited company, then please read our contracting through a limited company guide.
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Unfortunately, there are little benefits for individual contractors in terms of reducing tax liabilities. Due to this, contracting through an umbrella services company allows you to receive in the region of 60% of your earnings. You should also consider that umbrella companies’ service fees can be up to 9% of the value of your contract. For further details about this, see our ‘Income Illustration Examples’below.
Contracting through your own Limited Company will typically allow you to receive approximately 75-90% of your earnings, depending on your contract expenses and individual circumstances.
As previously mentioned, provided your contract falls outside of IR35 legislation you may pay yourself a small salary and then draw dividends from the company which are not subject to 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.
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.
Avoid Tax Avoidance Schemes through Umbrella Companies
It is important to point out that many umbrella companies are straying into the area of tax avoidance. You can spot these as they promise returns of 90% or more. Often you will also find that these companies mention a leading Tax Counsel or Tax QC. These are not the traditional employee umbrella scheme that you think they are but are instead an avoidance scheme. These are to beware of. Read more to find out why this is becoming such a big issue →
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, this includes invoicing, chasing payments and calculating tax and NI contributions.
As a director of your own limited company, you will be 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 such as the one we offer, the majority of this administration and paperwork will be managed for you.
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.
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 directly and you can then pay yourself.
Deciding which trading structure you should use ultimately comes down to what is right for you.
For most contractors, contracting through a limited company brings the most benefits. Though this is not the case for all.
The vast majority of contractors leave employment and join the world of contracting in order to increase their net income, as contracting rather than employment gives the opportunity for greater earning potential for the same number of hours worked and also the potential to keep more of what you earn.
By using an all-inclusive accountancy package you will be able to minimise your administrative duties whilst running your own limited company and still be able to receive approximately 75-90% of your earnings.
However, contracting using a limited company is not right for all. An umbrella company may be the better trading structure if any of the below points apply to you:
Points to consider
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.
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 earnings 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 firms 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 scenario before finalising your choice, please do not hesitate to call one of our dedicated advisors at Freestyle Accounting on 02476 426360 or complete the form opposite.
Further information about contracting through a limited company can be found in the following articles:
Why contract through a limited company? - Part 1
Why contract through a limited company? - Part 2
Best of luck with your Contracting endeavours!
The team at Freestyle Accounting
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