Outgrown your Umbrella?
Sometimes an Umbrella arrangement is exactly the right solution you need when you are a freelancer or contractor. There are other times when it will feel restrictive and doesn’t meet all of your objectives; usually tax matters and accounts control. But how do you get to grips with the differences without having to ask a solutions provider with a vested interest in the solution they offer?
- Intouch Contractor Accounting offers only Limited Company accounting solutions so please bear that in mind when you read on. Making the decision to become a contractor or freelancer is one of the most exciting and possibly rewarding decisions of your career. At first, you may not be sure if contracting is right for you, or indeed whether you would actually enjoy not being an employee.
- You were probably asking yourself all the natural questions that anyone in your position would be asking. Will your skills and experience be in demand? Can you get decent contracts to make it all worthwhile?
- With all these questions and plenty more besides, you may prefer to avoid initial long-term commitments while finding your independent feet and taking those first steps.
- Your day rate may start out relatively modest while you develop your skills, and saving tax may not be your biggest concern.
If contracting is likely to be temporary, an Umbrella is often the best place to start.
But after a year, or if you are convinced it’s a longer-term solution and the career plan you wish to follow, you should be aware of the differences and choices that are available as your circumstances change.
There may well come a time to make a positive choice to stay as an Umbrella worker or to consider being in business in your own right via your own Limited Company. The question of self-employment is a serious one. But, with the right professional support, the relative advantages or disadvantages should not be difficult to assess. Throughout this document we assume that the worker is outside of IR35. It’s a big assumption but true for most independent contractors. If you are in any doubt about whether your contract is likely to place you within or outside IR35, we can let you know very quickly. Give us a call on 01202 901 385 to chat through your options and find out where you stand, or email email@example.com
What can a Limited Company offer that an Umbrella does not?
- A way of trading during your contracting career that can continue beyond each contract • Ability to reduce your overall tax liabilities on income
- VAT advantages under the ‘Flat Rate Scheme’ Ability to claim more business expenses and raise your take home pay
- Possible longer-term tax advantages when you retire or cease to contract
- An ability to be in business with your spouse or partner (and some tax advantages)
- In many cases reduced professional fees!
- Limited liability commercially
- Greater control and flexibility in pension planning and income protection
A trading structure that is a legal entity in its own right
Trading through a Limited Company is a better option unless your contracting career is intended to be very short-term. Your Limited Company will be set up having discussed with you the choices in shareholders, directors and employees.
A professional adviser will do all the creation work on your behalf; you only have to explain your preference. This will include the registration of a PAYE scheme to pay yourself wages and pay the correct taxes to Her Majesty’s Revenue and Customs (HMRC). Your adviser will explain and should register you for VAT, most likely under the Flat Rate Scheme, and will also register you for Corporation Tax.
A Limited Company is a separate legal and tax entity and even though as director and shareholder you control it, it has to make returns and file accounts. The way trading lulls are dealt with is the subject of future professional advice based on your objectives and circumstances at that moment in time.
At all times the responsibility for all company returns remains with the directors but, again, in practice you should expect lots of support. It pays to look out for monthly fee services that include all essential compliance and admin tasks.
As a separate entity the life of a Limited Company is not related to any single contract. At the end of a contract the Company just carries on as if nothing has happened while you find the next contract. If you decide to return to employment, or to retrain between contracts, then your company can continue until you decide to take action to close it. The company could remain ‘ticking over’ or inactive until you are ready to resume contracting or it can cease trading and be wound up, either formally or informally.
The way trading lulls are dealt with is the subject of future professional advice based on your objectives and circumstances at that moment in time.
Lower taxation liabilities on your earnings
As an Umbrella worker you will be able to offset some professional fees against your income and some business expenses, before you receive the remainder of your earnings subject to income tax and National Insurance under pay as you earn (PAYE).
As an employee of the Umbrella Company the Umbrella Company itself will have to pay employer’s National Insurance on your earnings that will also be deducted from the net amounts paid to you.
By owning and controlling your own Limited Company you can determine how much of your total earnings you wish to take as salary, which will be subject to income tax and National Insurance (under PAYE). You can also control the timing and therefore the effective rate of your other income tax liabilities if you decide to pay dividends to supplement your income
Dividend income is taxed at different rates, depending on your other income in the tax year. Up to the basic rate threshold of £31,785 plus your personal allowance as shown on your tax code – say £10,600 (single person) for 2015/2016 – all income tax due is treated as being paid by a notional tax credit so that the individual has no more tax to pay. For amounts of dividend income between this level and £150,000 the effective rate is 25% of the net amount you receive. It would appear that paying income tax on dividends at 22.5% of the gross dividend (which is the rate of 32.5% less the notional credit of 10%) is more attractive than paying income tax at the PAYE rate of 40%, plus employer’s National Insurance.
However, don’t forget the Corporation Tax that the company incurs on its profits! Once you get into the higher rate brackets and you take this into consideration, the total taxes paid will both equate to 40%.
So even though the income taxes paid under either method are the same after taking Corporation Tax into consideration, the actual advantage in real terms is that dividends do not attract any employer’s or employee’s National Insurance Contributions (NIC) and are free of tax up to higher rates.
Any remaining ‘profits’ or earnings for that year that are not removed by salary or bonus from the company, will be taxed at the relevant rate for companies, which for most contractor companies is currently 20%
Since 2014 you can pay most salaries without incurring employer’s NIC. The employer’s Allowance deducts the first £2,000 of employer’s NIC from your company tax bill, meaning in most cases your company pays no employer’s NIC on your salary. You won’t get that from Umbrella company, who must deduct employer’s NIC at 13.8% of your salary from your contract income before paying you.
Being VAT registered under the Flat Rate Scheme (‘FRS’)
Historically, being registered for VAT was thought to be bad news and an administration nightmare: those days are gone. Your adviser does the VAT registration and administration each quarter and for many contractors the FRS generates a profit. Unless your services are treated as an export of goods and services you would normally calculate VAT at a rate of 20% (Jan 2015) and add this onto the charge to your client. Assuming your client is VAT registered they claim VAT back so it’s not a problem for them. Possible exceptions are charities and the financial services industry who may not be able to reclaim VAT, so some caution is recommended.
For businesses registered under the FRS, the calculation of the VAT liability due to HMRC is a fixed percentage applied to the gross fees (i.e. including VAT) that you charge your client, but you cannot reclaim VAT incurred on your purchases. The percentage rate assigned varies depending on the type of services your company provides and will have a 1% discount for the first year of VAT registration. At current rates the most common percentage rate for contractors in IT related services is 14.5%, but can be lower in appropriate circumstances.
Your adviser will deal with all the details and administration but the majority of contractors make a financial advantage as their actual VAT incurred on expenses is lower than the HMRC averages.
Imagine if you invoice your client(s) £60,000 in a year. You add on and get paid 20% VAT of £12,000. You will have to pay VAT based on, say, 14.5% of the gross fees (fees plus VAT charged) of £72,000. This would be a payment of VAT of £10,440. So you collect £12,000 and pay out £10,440 keeping the advantage before Corporation Tax of the difference: £1,560. However, don’t forget that you will have incurred some VAT on your purchases which in reality reduces this apparent surplus. Special rules apply for single purchases over £2,000 when the VAT may be recoverable, but you should seek advice when such a situation arises.
In theory, Umbrella workers too are entitled to seek compensation or reimbursement from the Umbrella Company for VAT on contractor’s expenses. In reality, some Umbrellas are more forthcoming with passing on this benefit than others.
You can register for FRS if your fees in the year of registration are below £150,000 (excluding VAT).
Maximise your business expenses and increase take home pay
There is no argument that the ability to claim business expenses legitimately against tax is maximised when using a Limited Company controlled by you. This is because the range of business expenses for which it is legitimate to claim is greater than when you are an employee of an Umbrella. Items claimed still need to be incurred wholly and exclusively for business purposes. More detailed examples can be found at www.intouchaccounting.com.
Expenses paid by your Limited Company can avoid you having to spend personal cash (which will have been taxed). However, non-business items could become taxable as ‘benefits in kind’. But once again, rather than fret about the different status of various expense types, these are matters you should simply expect your adviser to deal with on your behalf.
Professional fees paid to your adviser are allowable against company taxation so even then they cost less than it first appeared!
Long term benefits when you cease to contract
During the period when contractors and freelancers trade as Umbrella workers they are subject to income tax at their highest marginal rates on all of their income. For 2015-2016 this could be as high as 45%. Even more tax is deducted for employer’s national insurance by the Umbrella so the take home pay will be even lower.
The important point here is that all of the income is taxed in the year it’s earned at income tax rates.
One strategy observed by Limited Company contractors and freelancers is to restrict their income taken under PAYE or as dividends to only what they need to live on in a particular year. All profits not taken as salary are taxed at lower rates of Corporation Tax (currently 20% for 2015) and can be left to accumulate in the company.
By accumulating wealth in the company and investing surplus funds, investments will be subject to taxation at the lower business rate of 20% rather than generally higher personal income tax rates of 40-45%
Finally, when the contractor decides to close the company down, either by formal or informal liquidation or upon the contractor’s ‘retirement’ from contracting, then provided certain taxation criteria have been satisfied any resulting surplus may well be taxed as a capital gain rather than income. As a capital gain the rate of tax applied could be as low as 10% if Entrepreneur’s Relief is claimed. One of the pre-conditions for claiming Entrepreneur’s Relief is to have been trading for at least 12 months. There are other considerations so further advice should be sought in advance. None of these advantages are available to Umbrella workers.
Owning a business with your spouse or civil partner
Some find it difficult to live and work with their partners while others enjoy the support of their partners in their business. Typically, for husband and wife, especially when one of them has little or no other income, the structure of a Limited Company can be made very tax advantageous.
The details must always be appropriate and applied to specific relationships but in the right circumstance spouse arrangements have the ability to double the amount of income taxed at lower rate bands of taxation before higher rates apply. There are opportunities to have shares in your company owned by your spouse and use a combination of both salary and dividends to make use of any of your spouses unused basic rate tax band. This cannot be done under Umbrella arrangements.
Reduced professional fees
Often for commercial purposes it suits advisers to present their fees in an attractive manner, which can be misleading. When comparing services between advisers it helps you determine the real cost if the services delivered are matched like-for-like and stated in the same terms.
When checking income comparator models, be careful when expenses reimbursed are added to your take home pay! If you have made mileage, travel or subsistence claims at, say, £350 per month, this is not strictly ‘take home pay’. In physical terms it will be paid to you, but remember it is reimbursement for expenses and costs you have already incurred. In our experience many Umbrella models add these items when presenting you with ‘take home’ levels of income.
Compared to Umbrellas, Limited Company advisors perform many more tasks. They advise you on your questions, recommend planning solutions and undertake to make submissions on your behalf for yourself and your company – yet even on a direct cash comparison they are competitive.
For Intouch’s monthly accounting service you receive:
- Limited Company year-end accounts and tax return
- Personal tax return for main director
- PAYE scheme and salary taxes for two employees
- FRS VAT returns prepared and submitted
- Dividend advice and unlimited personal advice
- Structural planning advice for shareholders
- Mortgage references and our address as your registered office
- The Annual Return filing fee to Companies House of £13
Limited liability – commercial protection
While we all recognise the need for cost control combined with tax efficiency, Limited Companies also offer very safe commercial platforms from which to trade.
As mentioned earlier Limited Companies are entities in their own right and the financial exposure of the shareholders and directors, should things go wrong, is limited to the amount of their investment in the business. Assets and private wealth of directors outside of the business are protected against claims made on the company. There are instances when this can be challenged but they normally involve the directors acting recklessly, fraudulently or without care. They do not apply to ‘mistakes’. Even with the protection of limited liability we advise clients to take out standard commercial insurances for the work they undertake and for the rights of their employees.
Flexibility: pensions and income protection
Pensions are a very personal choice and will depend on a multitude of personal circumstances. Nevertheless, whatever your personal circumstances as an Umbrella worker, all of those options and more are available for Limited Company contractors. You can establish different types of company pension arrangements if that suits your objectives and your lifestyle.
Pension payments made through the Limited Company will get Corporation Tax relief (but always take advice). Personal pension contributions are paid net of basic rate tax relief, additional tax relief available is against tax paid at higher rates.
Income protection is another significant factor to consider. If for any reason you are ill, injured and unable to work, do you have sufficient protection and life or health insurance to maintain your lifestyle? Alternatives are more flexible in your own Limited Company. Speak with a professional financial service adviser to understand what could work best for you.
Agency Workers Regulations (‘AWR’) – friend or foe?
AWR, which entitles temporary workers to pay and conditions equal to that of permanent staff after 12 weeks is at best going to put more pressure on the income levels of Umbrella workers. Contractors working for temporary workers agencies (Umbrellas) will become entitled to additional employment rights. These additional rights, including payment between assignments (‘PBA’), inevitably have financial consequences in the supply chain, somewhere between the end hirer, the agency and the Umbrella.
The general consensus is that, even though it will take a while for various models of PBA and Swedish derogation to settle down and be tested in the employment courts, the financial pressure to pay for the additional rights and extra compliance paperwork will fall on the contractor.
Limited Company contractors who are ‘genuinely in business on their own account’ are outside of the scope of AWR. Being outside of the scope of AWR removes from workers the protections that it was designed to offer. However, some of the protections and equal rights sought under AWR, such as holiday pay or sick pay, can be established in Limited Companies if the contractor chooses.
AWR employment law protection against losing your job exists but can often be more procedural than real – and most of us recognise that redundancies happen when it suits the employer!
Being Limited really does make perfect sense!
- A business, not just an employee Lower tax rates on dividend income
- No National Insurance contributions on dividends
- Additional shareholder to increase tax allowances
- Financial control over income
- Tax efficient exit strategy
- Easy to sign up
- Easy exit
- Minimal paperwork
- Statutory sick, maternity and paternity pay
- Less registration
- Director’s responsibilities
- Administration, paperwork and filing returns
- Accountancy fees
- Business insurances
- IR35, S660A
- An employee, not a business
- No control over income
- Umbrella costs recharged
- Umbrella fees
- Less take home
The Perfect Mix of Team, Technology & Expertise – all for a monthly fee
Intouch Accounting are Limited Company accountants who advise 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 also 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. Why not explore what becoming a Limited Company contractor means for you?
Give us a call on 01202 901 385 or visit www.intouchaccounting.com and we can go through your circumstances and advise on what is best for you.
We look forward to hearing from you soon