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Limited Company or Umbrella – which is the right choice for you?


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Limited Company, Umbrella or Sole Trader – which is the right choice for you?

Guide for freelancers and contractors: Limited Company, Umbrella, or Sole Trader – which is the right choice for you?

No matter how long you’ve been contracting, maximising your take home pay is likely to be high on your priority list. To get the best experience of contracting it’s a good idea to select one of the popular trading options that best suits you. What may at first appear to be the best option (or simply the easiest) may not be the most suitable or tax efficient in the long run. Add to this changes in tax laws, even if you have been contracting a while, you should always remain aware of how circumstances change and the effect they may have on you.

Navigating through the options may seem daunting, but the choice you make is likely to have an impact not only on your employability in certain sectors but also the overall taxation liability you suffer on your earnings.

In other words, it can hit you in the pocket, especially if tax rules change. Ideally, it’s worth talking your options through with a reputable professional contractor accountant who will be able to advise you on the specifics and it shouldn’t cost you anything to do this. However, there are general guidelines, or ‘rules of thumb’, to take into consideration which can help you make an informed decision and choose the right trading option for your circumstances.

This guide outlines:

  • the four most popular options to choose from
  • what circumstances each option is generally most appropriate for
  • advantages and disadvantages of each
  • how they compare to one another in key areas.

Your options-at-a-glance

Umbrella

  • Take home approx. 65-75% pay
  • Non visible accounts
  • Reliance on third party to collect payment – which may lead to delays
  • Currently hostile targeting of Umbrella companies by both Government and Unions
  • Minimal control, you must trust the Umbrella to make decisions
  • Costly as tend to pay more overall tax on income
  • Some relief for claimable expenses (not as extensive as being Limited)
  • Good option for contractors intending to to contract no more than 9-12 months
  • Low commercial risk
  • Minimal paperwork and administration
  • Quick and easy to set up and leave – no dissolving or formation costs
  • The Umbrella company takes responsibility for liability, therefore the contractor is not liable
  • Monthly fees to Umbrella for administration and account management
  • Less administrative responsibilities
  • Employee of the Umbrella

Sole Trader

  • Non visible accounts
  • Joint control over financial decisions and running of business
  • Getting a bank loan is more difficult due to high levels of bankruptcy amongst Sole Traders
  • Complete individual/ shared hands on control of the business
  • Significantly less tax efficient than operating as a Limited Company
  • Benefits from Flat Rate VAT scheme and more claimable expenses
  • Good option for contractors wishing to have similar tax benefits to Limited Companies, but without long term contracts
  • Combined personal and financial risks, meaning the contractor is personally liable for any financial difficulties
  • Increased administration and legal responsibilities for the running of the business
  • Quick, easy and low cost to set up
  • Shared personal and business liabilities should things go wrong
  • No fees – although much greater self management of accounts is required
  • Director’s responsibilities
  • Your own boss / Director

Limited

  • Take home approx. 75-80% pay
  • Financial and account information is made public
  • Full control over financial decisions and running of the business
  • Highest level of considered professionalism, and can raise overall social standing and employment success
  • Complete hands on control of the business
  • Higher rates of take home pay due to increased opportunities for tax efficiencies
  • Benefits from Flat Rate scheme and more claimable expenses
  • Good option for contractors intending to contract more than nine months as a full time occupation
  • Low personal risk as the company’s finances are separate to personal finances
  • Increased administration and legal responsibilities for the running of the business
  • Will take some time, administration and initial costs to set up
  • Limited personal liability as company assets are separate from personal assets
  • Monthly fee to contractor accountant for them to manage the Limited Company’s accounts
  • Director’s responsibilities
  • Your own boss / Director

Is setting up as a Limited Company the right choice for me?

If you are intending to be a career contractor, in it for the long-term, you are most likely to be better off in real-terms by forming your own contractor Limited Company. Owning your own Limited Company gives you complete control over your finances and your business, offering all the freedom and lifestyle enhancements that go with this. You get to choose how you organise your tax planning to reap the maximum net income for your efforts and you get to choose how much you need to work to achieve your financial goals.

Ready for a change?

If you are currently operating under an Umbrella or as a Sole Trader and are thinking it is time to make the move to being incorporated, contact us to discuss your options. If you have decided you are ready to set up your own Limited Company we can ease you through the process and provide expert advice. We have in-depth day-to-day experience of setting up contractor Limited Companies and know what works for contractors exactly like you. We can help you get up and running and enjoying the tax savings, freedom and control of owning your own company.

This guide provides more detail about your choices. It’s important you consider all of this information carefully before you make a decision

First things first: what to consider

You have four very different options available in terms of how you choose to provide your contracting services:

  • Being employed by an Umbrella Provider.
  • Being your own boss – setting up your own Limited Company.
  • Being self-employed (working as a Sole Trader or in a Partnership).
  • Working through an agency payroll (temporary) solution.

When deciding which option to choose take some time to consider the following factors to make sure you get the best personal (lifestyle), commercial and tax efficient fit:

How long you are intending to contract for – some trading model options are more suitable if you are going to be contracting for the short-term (3-9 months), while others make more sense if contracting is a long-term career choice (9 months+).

How much you anticipate earning annually – some options, such as Umbrella, are more suitable for lower end earners, but if you anticipate earning over £25,000 per year you’re probably better suited to a Limited Company.

How you envisage working with your clients – a consultant may advise many different clients during a year; a contractor may work for only one or two clients on a few bigger jobs; while a freelancer may work for many different clients on lots of smaller jobs where self-employed as a Sole Trader or in partnership is more acceptable to clients.

How much commercial risk you will be exposed to – some roles carry more commercial risk than others. Risks can normally be covered by insurance, but the added protection of a Limited Company helps with your personal financial security. Consider where your engagements are likely to sit on the risk scale as well as the exact wording regarding liabilities for risk factors in your contracts.

How disciplined you are with administration (this includes timesheets and invoicing) – only you can know how much administration you are prepared to do, so be honest with yourself and how much help you need!

Have a go at answering the following questions before reading more about your options as they will either help confirm ideas you already have or provoke more thought. Remember, you can always switch options if your circumstances change and your original choice no longer works for you.

  1. Are you disciplined enough to work hard at making a success of your career as a contractor
  2. Is there a market for your skill set and experience?
  3. Do you know your own strengths and your limitations, so that you do not oversell yourself?
  4. Are you flexible and able to adapt quickly to new environments and varying projects?
  5. Do you know your market value and is your rate competitive? What are others in your field charging?
  6. How are your negotiation skills and will you be able to ensure you get the right rates to keep your business profitable?
  7. Do you have a strong network of contacts to keep those referrals coming in?
  8. Are you a people person and will you be able to deal with new colleagues and varying levels of demands?
  9. How will you make sure you meet your training needs and keep up to date with knowledge and new developments relating to your area of expertise?
  10. Are you organised enough to manage your finances and to put funds away in case of a rainy day?

Your options: most popular ways in which contractors engage with end hirers to provide their services

Now we will consider in more detail the different trading models you can select to suit your circumstances:

Option: As an employee of an Umbrella company

An Umbrella company acts as your employer for work done by you for the client. With this option you will need to complete timesheets, along with any expenses details and submit them to the Umbrella company. They will then issue the client with an invoice on your behalf and pay you a salary based on your timesheets and expenses with deductions made for PAYE, National Insurance (NI) and their monthly fee or percentage of earnings. The Umbrella may also deduct from your salary amounts for holiday pay and pension contributions. They will provide you with very limited employment rights and pay over taxes on your behalf. In layman’s terms and as simply as possible: Umbrellas facilitate the administration of operating as a contractor by collecting fees from the agency or end hirer, calculating, deducting and paying HMRC your taxes, and paying to you the balance, after of course deducting a weekly fixed fee, or taking a margin based on your income.

Historically Umbrella’s deducted your expenses before calculating the tax they deduct and pay your expenses in full. From April 2016 expenses cannot always be treated in this way, and you may find that you have to prepare a personal tax return to get back tax the Umbrella has deducted on the expenses that you paid.

The UK Government has become very concerned that some Umbrellas are noncompliant. It’s always important to choose the right provider and to make sure that they follow the rules properly.

Advantages of using an Umbrella company

Short-term option

It’s easy to start and easy to stop so can be useful for those who are only planning to contract for a short period of time (3-9 months.)

Good for dipping your toe into contracting

Working with an Umbrella company is often the first option for new contractors as it’s quick and easy to set up and can be a good way to test the water in contracting without setting up a Limited Company.

Less administration

Included in its fee the Umbrella deals with all the paperwork and tax elements on the contractor’s behalf so there is also minimal administration involved. Additionally, if you decide to stop contracting, there are no associated costs for doing so.

 

Calculator

For an idea of the difference in take home pay between an Umbrella and a Limited Company set up, try out our free, easy to use Contractor Take Home Pay Calculator

 

Disadvantages of using an Umbrella company

Less take home pay

As a general rule your take home pay will be substantially lower than other options because many expenses will not reduce your tax, and other benefits (see below) are not available to you.

Higher cost

This option can work out to be the most expensive tax wise. You will pay more tax under an Umbrella as your total salary will be liable to income tax and NI in the same way as a full-time employee BUT you also meet the employer’s NI cost out of your income. You also lose out by not being able to take advantage of Flat Rate VAT.

New tax rules

From April 2016 obtaining tax relief for expenses will become very difficult for Umbrella workers. Umbrella companies cannot pay you expenses without first deducting tax and NI. You can claim tax relief if you then complete a personal tax return and prove your expenses meet very strict criteria. You will automatically be unable to claim mileage, travel or subsistence for journeys to work if your client has any right to control what you do.

The removal of tax relief on expenses is very expensive for Umbrella workers who will suffer not only Income Tax between 20% – 45% but also additional combined NI Contributions of 22.67% on the expenses that are no longer allowed.

Less control

Using an Umbrella means you lose the freedom of making your own financial decisions on your earnings as these are all made for you by the Umbrella company. It also means that you are reliant on the Umbrella to collect payment, which could potentially result in delays.

Perception

Generally using an Umbrella is perceived as an interim solution for newer or short-term contractors. This can be fine if you are only planning to contract temporarily. However, if you are intending to establish yourself in the contracting world for the long-term, particularly if you are working for larger companies and governmental organisations, it’s worth considering alternatives.

Taxation and employability issues

Umbrella companies are increasingly being unfavourably targeted by both the Government and industry sector Trade Unions. Their actions may limit where you can work. Recent action by the government to curb tax relief on expenses means that many Umbrellas will be looking to switch their workers to hybrid forms of Limited Company.

A few words of caution to anyone offered alternatives arrangements; few Umbrella companies are properly qualified as accountants and their hybrid solutions may be based on untested areas of the law and may not work for you. Those Umbrella workers looking to the future would be best advised to look at all their options and not just accept the first one their current provider offers.

Summary of Advantages & Disadvantages

Advantages of using an Umbrella company

  • Quick and easy to set up and to leave – no costs of forming or dissolving a company.
  • Minimal paperwork and administration.
  • Low commercial risk.
  • Good option for those intending to contract for no more than six to nine months

Disadvantages of using an Umbrella company

  • Costly as tend to pay more overall tax on income than working through a Limited Company.
  • Less tax relief than other options and you may need to file a personal tax return if you want any chance of tax relief on expenses
  • Reduced flexibility for management and investment of surplus income
  • Minimal control – must trust the Umbrella to make decisions.
  • Reliance on third party to collect payment which could lead to delays.
  • Currently hostile targeting of Umbrella companies by both Government and Unions.

 

Option: As a Limited Company

These types of companies are also called Personal Service Companies (PSC); Owner Managed Businesses (OMB); small to medium enterprises (SMEs); or one man bands. In essence they are all the same vehicle and the different names create no distinction.

Setting up as a contractor Limited Company creates a separate legal entity which can make its own profit and has liability for taxes in its own right. With this set up your business cash and assets are treated as separate from your own personal cash and assets. This gives the contractor a layer of protection if the business gets into financial difficulties because, unlike a Sole Trader, there would usually be no claim on your personal cash and assets to set this right.

Constitutionally these Limited Companies generally only have one shareholder and one director (who is the only employee) and invoices are raised in the name of the company to the end hirer for work and services performed by the director. It is not unusual for a contractor trading through a Limited Company to have their partner as a second shareholder and second employee. Depending on other circumstances this can significantly enhance the overall attractiveness of using this type of vehicle.

Advantages of setting up a Limited Company

Tax efficiency

Generally, if you are expecting to contract for more than one client for more than nine months and expect to earn more than £25,000 p.a. setting up a Limited Company will be the most tax efficient option for you. Using a favourable balance of salary payments to yourself as an employee (director) and dividend payments as a shareholder (owner) of your business can legitimately help you get the most from your income by maximising tax savings. In addition, there are also legitimate tax efficient ways of organising elements such as payment of VAT, Corporation Tax and Capital Gains Tax. Ideally, work closely with your contractor accountant to ensure you have the most tax efficient financial planning.

Setting up as a Limited Company can also potentially benefit those expecting to earn less than £20,000 p.a. in some cases, so if this applies check with a professional contractor accountant to ensure you get the best advice and choose the right option for you.

IR35

To get the maximum tax savings through your company it is essential that your contracting activities are deemed by HMRC as being ‘outside IR35’. This means you are treated as genuinely working ‘in business on your own account’. This definition is the difference between being taxed as a genuine contractor and being taxed as a ‘disguised employee’. If taxed as a ‘disguised employee’ the income tax and NI Contributions will increase, which will reduce your overall tax savings. HMRC assesses each contract individually on its own merits. To avoid doubt regarding your IR35 status it is a good practice to have all your contracts reviewed for IR35 compliance by a professional contractor accountant.

Low personal financial risk

A Limited Company is a distinct legal entity so the company’s finances are separate from the shareholder’s/s’ personal cash and assets. This means that if, for whatever reason, the company should dissolve, your personal finances are secure.

Perception

Being the director of a Limited Company carries a certain weight in the business community and gives the overall impression of being professional, competent and serious about your contracting career. As being a director of a Limited Company has certain legal responsibilities and obligations, it may raise your overall social standing. The fact that your accounts are available as a public record also means that the financial status of your business is easily verifiable. These factors can open doors for you and help you in securing contracting work.

Employability

Many agencies and some organisations – particularly governmental bodies – will only engage Limited Company contractors. Current Government and Union pressure on the use of Umbrella companies, along with the reluctance of agencies to use Sole Traders, means that the Limited Company option is becoming increasingly attractive. This is why the majority of long-term contractors are now choosing the Limited Company route.

Disadvantages of setting up a Limited Company

Setting up

Forming a Limited Company involves some initial costs and administration, whether you form one from scratch or buy one ready formed. The good news is, incorporating a company from scratch can usually be done in a matter of hours.

Although the onus is on you to set up your Limited Company, a contractor accountant can do a lot of the work for you to make the process as quick and painless as possible (at Intouch, we would take care of all of the above for you within your monthly fee. Click here for more details.

Administration and your responsibilities as director

You will be both a shareholder (as owner) and an employee (as director) of your company which means you will have a number of legal responsibilities within your business. If you engage the services of a reputable specialist contractor accountant then they should guide you from the offset to ensure you meet these requirements.

Increase in accountancy costs

Due to the complexities of running a Limited Company many contractors choose to engage professional contractor accountants to help them. This may increase the cost compared with self-employed Sole Traders or Partnerships, but surprisingly, accountancy costs are often similar to Umbrella weekly fees and the tax efficiencies enjoyed are far greater.

Summary of Advantages & Disadvantages

Advantages of setting up a Limited Company

  • Higher take home pay due to increased opportunities for tax efficiencies.
  • Limited personal liability as company assets are separate from personal assets.
  • Full control of financial decisions and running of the business.
  • Benefit from Flat Rate VAT scheme and more claimable expenses.
  • Positive connotations of being a Limited Company to potential clients.

Disadvantages of setting up a Limited Company

  • Increased administration and legal responsibilities for the running of the business.
  • Not a suitable option for short-term contracts or those intending to contract for less than 3-9 months in total.
  • Costs involved in dissolving the company, if required.

Option: As a Sole Trader or in Partnership

A Sole Trader is a self-employed individual who trades as an individual in their own name or with a trading name that does not include the word ‘Limited’ at the end! An example would be:

David Cameron Services, or David Cameron Trading as: Cameron and Co, Ministers and Politicians.

Income generated through their contracting business is calculated alongside any other personal income for tax purposes. Sole Traders are more common in some specific industry groups and job roles. Consultants, creatives and journalists tend to be Sole Traders, often called freelancers. Typically they would have a number of clients concurrently either on retainer or for a series of short project-based assignments.

Until recently large numbers of workers in the construction sector were self employed under the CIS scheme. Casual workers, seasonal workers and large numbers of workers in the transport and healthcare sectors were also operating in the manner of being self-employed. However, legislation to remove ‘false’ self-employment as part of the on-shore intermediaries review has pushed many of these workers into either agency payroll agreements or into Umbrella employment. Unions believe that employers have promoted the shift towards Umbrellas for some lower paid and vulnerable workers in order to reduce their costs and pay below the National Minimum Wage.

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 their individual share of the income, as set out in the Partnership agreement, as if they were Sole Traders.

Advantages of setting up as a Sole Trader or in Partnership

  • Setting up is very easy. Unlike a Limited Company there is no separate legal entity formed so there are very low set up costs – all you need to do is inform HMRC.
  • It offers complete control of finances and has many of the taxation advantages of a Limited Company but without the formality. It also means your contractor income is not publicly viewable.

Disadvantages of setting up as a Sole Trader or in Partnership

Administration

A Sole Trader has responsibility for all of their trading administration. They must maintain accounting records and produce an income statement at the end of each tax year. They must also collect payments for work done, organise professional indemnity and ensure payment of their tax liabilities.

Anti-avoidance legislation

If individuals are genuinely in business on their own account then operating as a Sole Trader can be very efficient. However, for the lower skilled manual workers, and for lower paid workers there is general suspicion that they are not in reality self-employed and they have to demonstrate that they are not under the direction, supervision or control of the hirer. If they cannot do this then they will be taxed as employees. The risk of this is passed on to agencies and end hirers, hence the reason for them becoming less popular at lower income and lower skill levels.

Personal risk

Unlike a Limited Company or an Umbrella worker, the personal and business finances of a Sole Trader are combined. This means that if the contracting business gets into financial trouble, the Sole Trader is personally liable and their private assets could be at risk.

Tax efficiency

Depending on your income level, you may lose out on a number of tax savings which would be available to you if you were operating using a Limited Company.

Perception and employability

Many agencies will not deal with Sole Traders due to the potential risk of them becoming liable for a Sole Trader’s tax liabilities if they are unable to pay them, or more topically the workers being ‘deemed employees’ under IR35 and other anti-avoidance legislation (for more information on IR35, take a look at our FAQs)

Summary of Advantages & Disadvantages

Advantages of setting up as a Sole Trader or in Partnership

  • Quick, easy and low cost to set up.
  • Complete hands on control of the business.
  • Financials/accounts remain private.
  • Tax efficient if genuinely self-employed

Disadvantages of setting up as a Sole Trader or in Partnership

  • Combined and unlimited personal and business liabilities if things go wrong (unless insured separately).
  • Potentially less tax efficient than operating as a Limited Company.
  • Getting a bank loan is more difficult because Sole Trader bankruptcy is more frequent.

Option: As an agency payroll, or temporary, worker

We refer to this here for the purpose of completeness but for career contractors and freelancers it is not a popular choice as the other options all have significantly more advantages. This option is not popular amongst contractors or freelancers as it confers no benefits over and above the Umbrella model (see below) and in most respects follows the rights and obligation for full-time or part time ‘permanent employment’ regulations after the initial 12 week period. This option is often associated with short-term, lower paid, seasonal or casual labour.

An agency payroll provider (temporary worker agency) provides the worker to the end hirer, on often short-term assignments. The agency payroll is responsible for deducting full taxes of PAYE and NI and will pay the worker the after-tax amount. After working at the same hirer for more than 12 weeks the employee will qualify for employment rights.

Ready to get started?

If setting up a Limited Company sounds like the right option for you, or if you want to talk it through in a bit more detail before you decide, call us on 01202 901 385 or email enquiries@intouchaccounting.com

We can help you set up your own company within a matter of hours and get you on your way!

I already have a Limited Company – will switching to Intouch save me money?

If you already have a Limited Company and are currently working with another accountant, switching to Intouch is easy to do and could save you both time and money. Call us on 01202 901 385 or email enquiries@intouchaccounting.com for more information and an initial chat.

If you would like an idea of how much you could be saving with Intouch try out our easy to use Cost Camparison Calculator

If you have already set up a Limited Company and are not sure what to do next or if you want to chat through how to get started, call 01202 901 385 and we can go through your circumstances and advise on what is best for you.

Why choose Intouch?

The perfect mix of team, technology and expertise for a monthly fee

Intouch Accounting are specialist Limited Company accountants advising thousands of contractors and help many of them overcome issues with the taxman everyday. We have an experienced friendly team who can set up a company for you, manage your accounts and provide ongoing advice in relation to investing surplus cash. As an Intouch client you will get 24/7 access to our innovative client portal, which saves you time when managing expenses and invoices and lets you know where you stand at all times.

What becoming a Limited Company contractor means for you?

Give us a call on 01202 901 385 or email enquiries@intouchaccounting.com and we can go through your circumstances and advise on what is best for you. We work with contractors every day, helping them to understand their options, make the right decisions for their businesses and save money.

We look forward to hearing from you soon