Umbrella vs Limited

When starting life as a contractor, one of the biggest decisions you face is how to structure your finances and how you’ll get paid. If you want to stay compliant, there are two clear choices – either operating through your own limited company or through an umbrella company and there are pros and cons to consider with both options. Both are perfectly legitimate and compliant, as long as they are operated in the right way.

Umbrella Company

This is essentially where you become an employee of the umbrella company and therefore you are subjected to PAYE tax and national insurance (employee’s and employer’s), as well as a fee charged by the umbrella itself.

You would be asked to submit time sheets to your agency or the umbrella company, who then deal with invoicing your agency or the end client for the work you have undertaken for them, collecting the cash and passing it on to you, having deducted the relevant tax and fees.

On average, with an umbrella, you are likely to take home around 65% of the contract’s value.

However, the option to go through an umbrella company is more simple than using a limited company – you simply submit your time sheet and expense details, then when you are paid, the tax and national insurance is already deducted.

Limited Company

With a limited company arrangement, it is the company itself that invoices the agency or end client and receives payment. You will be a director and shareholder of the company and as such will control it and will be entitled to receive a salary and dividends (a share of the profits) from the company.

The initial step is to have a company formed (incorporated) and then arrange for its own bank account to be set up (a must), all of which we would be able to assist you with.

The company itself is a separate legal entity from yourself. As a director of the company, you are responsible for all company related matters such as invoicing, maintaining the bookkeeping records, determining what you take out of the company as remuneration, and accounting for tax. The company’s details are also held on public record at Companies House. However, these aspects can substantially be handled by your accountant.

The contract you have with either the agency or the end client will then be in your company’s name as opposed to your personal name.

Under a limited company, your take home pay would be at least 80% of the contract’s value so do would earn more money through this option. This is because:

 

  • You can receive income as a mixture of salary and dividends, the latter of which do not attract national insurance
  • You can claim a wider range of expenses against your income
  • You can account for VAT under the flat rate scheme, which for contractors normally adds a few percent to the take home value
  • You control how and when you invoice your client or agency

So, the biggest benefit of having a limited company is that you pay less tax and national insurance. Other benefits include a separation of liability between yourself and the company and a more professional image.

Whilst there is an element of additional work required as director, using an experienced contractor accountant will take all of this hassle away. You should receive a clear explanation of your responsibilities and the tax you’ll pay and the fees are no higher than those charged by an umbrella company anyway. You’ll need to keep a few records, but with an online system this should only take around 15 minutes per month, including the invoicing of clients.

Which option is best for me?

For tax-efficiency, greater take-home pay and from a control perspective, the best option for most contractors is nearly always a limited company.

However, if you are only contracting for a short period of time (say 3 months or less) before going back into full-time employment, or your daily rate relatively low, an umbrella solution may be advisable. To ensure you can maximise the advantages of using a limited company, the impact of IR35 legislation also may be a consideration (click on the link for more info on IR35).

Everyone’s circumstances are different. We are able to offer impartial advice and to assist with all your company, accountancy and taxation needs, so please contact us for more information.

Posted by Beth Hogg