Becoming a contractor with an Umbrella Corporation or a contractor of a Limited Company?
Either an Umbrella or a Limited Partnership Contractor? …We will help you
A problem that many contractors face is figuring out the right arrangement for your business. Although the single trader path remains a common choice for others, some prefer to create themselves with an umbrella company as a limited company or deal. Still, it can be tricky to find out which is the right route (a limited vs umbrella company) Indeed, of the 5.8 million small companies in the UK, over half are sole traders (3.5 million) and 2 million are restricted businesses, as estimated by the National Federation of Self Employment & Small Businesses.
The sector in which you work or the financial set up that works best for you will decide which path to take. They will only be able to pitch for some jobs by working under an umbrella firm for certain contractors. Restricted partnerships or private sector companies, respectively, benefit from higher tax efficiencies and financial security.
Here is a simple definition of what both do before deciding which business structure could fit better for you:
Limited market clarified
You become the director and are completely accountable for all your corporation do when you start up your own limited company. As a manager, you are in charge of the customers you take on and the transactions that your firm makes, which ensures that it is up to you to ensure that you comply with all contractor-specific rules such as IR35 and manage the tax collections, calculations of payroll and returns. The advantage is that this is the most tax-efficient business structure-you pay yourself in the form of a low basic salary and draw the rest of your earnings in the form of dividends that are not subject to national insurance contributions.
Umbrella sector clarified
There’s not the same amount of liability for contracting with an umbrella firm. You will also pick what job you take on and how you operate, but in essence, you are regarded as an employee by the umbrella organisation. When you’ve done work with the customer, you sign up with them, and they pay you. The advantage here is that all tax deductions are managed, and much of the financial responsibility is taken up by them. For contractors that are just starting, it is an enticing road.
The pros and cons weighing up
Here are some of the key distinctions between a limited partnership and umbrella company contracts, both the pros and cons, to help you pick the most suitable set-up for you.
Admin and Roles
Restricted company: There are many regulatory and financial responsibilities for directors. Within a few hours, they will set up the business, usually with the assistance of a professional contracting accountant who will direct them through the process. It will take up to a few weeks to apply for taxes (VAT and Income Tax). To ensure their accounts are up to date, directors will need to conduct routine admin tasks. Both customers invoicing will also be done by them.
Umbrella business: Umbrella company employees have no legal obligations and should be set up with a contractor professional directly. The cost of administration is low. In their behalf, contractors send their timesheets and invoices to the umbrella firm to manage all tax deductions.
IR35 and Tax
Restricted company: This is the most tax-efficient way to contract, as previously reported. That’s how most directors chose to take a low wage and give themselves the majority of their salaries in dividends, which are excluded from social insurance deductions (up to the full income tax allowance). They may also schedule their tax contributions in a highly versatile fashion to optimise the use of lower tax bands by scheduling dividends. However, if they miss an IR35 test, new off-payroll tax laws called IR35 hit limited company workers with higher tax rates, ensuring they forfeit most but not all, tax gains from being restricted.
Umbrella Corporation: Since you are treated as an umbrella company employee, your entire income is charged into the PAYE scheme, which automatically deducts all taxes and social insurance payments. This set-up is less tax-efficient than operating with a limited corporation and ensures that you have very little tax preparation options. Still, it also reduces any financial and administrative pressure. A bonus is that IR35 since you have always been taxed is meaningless.
Controlling
Limited company: You are your own company’s director, and this means you have a high degree of control over your company. Decisions are entirely up to you about who you work with what clients you take on and how you handle your accounts.
Umbrella Company: You have little control as you are an employee of the umbrella company, but you can still choose what work you take on. You benefit at the same time from avoiding the hassle of running your own company.
As you can see here, both business structures have pros and cons. While some people are influenced by the tax efficiencies they can gain from setting up their own limited company, others prefer the flexibility and freedom that comes with working for themselves, yet having an umbrella company do the administration for them.
Please contact our team of tax specialists for no-obligation advice if you want to learn more about contracting and need help navigating IR35. For the latest industry insights, you can also head over to our Knowledge Hub.