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Every day contractors ask us questions about tax and accounts, things to do with their Limited Company, or just general business questions. This is what we tell them.

Q: What is an agency (PAYE)?

Agency (PAYE) is similar to the Umbrella solution but not as tax efficient. The Agency, normally a recruitment agency, will calculate your tax and national insurance liability for you and collect the total due under the contract from the customer. The agency will then pay you the balance of your salary.

Unlike the Umbrella arrangements you are not employed by the agency and as such you cannot claim for your business expenses for items such as travelling and subsistence. They do take away the hassle of the paperwork but you do not gain employment rights or the ability to claim for your expenses.

Q: What are partnerships?

Partnerships are extensions of sole traders. More than one consultant will group together, forming a partnership, to find contracts, share skills and resources. The nature of the business arrangements for sharing costs and profits are normally explained in a partnership agreement.

For taxation purposes each partner will be taxed on his/her share of the income as set out in the partnership agreement as if they were sole traders.

Q: How is a sole trader taxed?

Any income of a sole trader is assessed on the individual in the tax year in which it is earned. Income is taxed at income tax rates in force at that time. If the same level of fees is earned by a contractor using a Limited Company the ability to have some of the income taxed under income tax rates and some under corporation tax rates results in lower amounts of tax overall.

Q: What are the responsibilities of a sole trader?

In several ways working as a sole trader has many of the freedoms of operating your own Limited Company with less of the formality. While this option has less formalities than a Limited Company, a sole trader is still responsible for the maintenance of accounting records, the production of an income statement, collection of fees, professional indemnity insurance and payment of taxation.

Q: What is the legal identity of a sole trader?

A sole trader has no separate legal identity from the individual and no registration is required other than to inform HMRC of its existence. From a commercial point of view individual sole traders do not have the same protections as a Limited Liability Company and the question of professional indemnity insurance is even more necessary. Further, remember that because of the potential employment risks involved agencies may be unwilling to find contracts for sole traders.

Q: How do you claim expenses through an Umbrella company?

Your take home salary, (while dependent upon your contract with the ultimate customer after deduction of PAYE and NIC) can be increased when legitimate business expenses can be taken off your income before the tax due is calculated. This is normally done for you by the Umbrella company.

Q: What do Umbrella companies do?

Umbrella workers are employed by the Umbrella company which deals with the ultimate customer. The Umbrella entity performs all of the necessary administration that would otherwise fall to the contractor in return for a fixed fee. As a contractor employed under an Umbrella arrangement for tax purposes you are treated very similar to a “Permie”.

Q: Is a Limited Company right for me?

If you want to run your own business that has its own legal identity and can earn profits and pay taxes in its own right, then having your own Limited Company could be right for you. For contractors with an annual income of more than £35,000 this trading model is often the most tax efficient.

Q: How does a Limited Company work?

A Limited Company is a separate legal entity in its own right, meaning it enters into contracts, owns property, will generate income and incur expenses in its own right and independent from its owners and directors.

It will have its own bank account that is kept entirely separate to the directors private bank accounts.

A company is owned by shareholders and run by directors, who are often one and the same in smaller companies. By choice a company can also have a company secretary, although this is not a legal requirement. Shareholders can be paid dividends, and the amount paid must usually be paid in proportion to the shares held. A more complicated share structure can be discussed on request. You are an employee of your Limited Company, not self employed, and will usually take a wage to reflect that. As company director you are legally responsible to act in the best interests of the company and for the submissions the company is required to make.

Q: Which company trading structure should I choose?

The structure you choose to trade under as a contractor has commercial, financial and tax consequences but the best choice for you will be determined by your individual circumstances, your desire to maximize your take home wages and views on risk and any administrative burden.

Increasingly the most popular and generally the most tax efficient contractor trading model is contracting through a Limited Company. However, it does require a commitment to the lifestyle of being a contractor and offers the rewards of freedom, flexibility and control over your career path.

Whichever route you choose it is important that you have discipline and comply with the legislation relevant to running a business.