Accountant

LIMITED COMPANY OR PAYE UMBRELLA – Which Would be the Right Choice for Contractors?

Limited Company vs. Umbrella Company

This write-up compares the two key business structures used by contractors – the Limited company and Umbrella Company.

Overview:

Limited Company:

It is advantageous for a contractor who doesn’t mind managing the company’s financial affairs and some additional paperwork. In such a scenario, forming and operating one’s own Limited Company can make a significant difference to the amount of cash that ends up in the pocket each year. Instead of being employed by an Umbrella Company, the contractor becomes both a Director and a Shareholder of his company and can then pay a Director’s wage, vote dividends and claim legitimate expenses back from the company all according to the latest financial information.

Umbrella Company:

The advantage of working for an umbrella company is to get most of the benefits of self-employment without all of the extra hassle. Umbrella companies are beneficial for contractors who want to have a fully managed risk free payroll solution.

If a contractor chooses to operate as a limited company, for example, then the contractor might be able to take advantage of more generous tax arrangements to boost their take home pay.


Comparison: Limited Company or Pay-as-you-earn (PAYE) Umbrella

A lot a factor need to be considered by a contractor when making this choice. Every contractor in every industry has different needs and circumstances. It is important for a contractor to consider a few key questions including:

  • How much can they be involved in the financial/administration side of things?
  • Will my contract fall under the IR35 – hidden employment tax regulation?

Advantages of Limited Companies:

  • Less taxation liabilities – more take home amount
  • Longer term company structure
  • Limited financial liability if the company is unsuccessful
  • Greater legitimacy with clients and suppliers
  • Essential to grow the business
  • Most agencies and end clients will only want to deal with Limited Companies

Advantages of Umbrella Contracting:

  • Full employment rights such as statutory sick pay and statutory maternity pay
  • Better access to mortgages and other types of credit
  • Less responsibility and no special legal duties
  • Good for lower-paying contracts – easy and fast registration
  • Employee Insurance cover included in the package
  • Generally preferred by employment agencies

Parameters

Limited Company

Umbrella Company

Bank Account Status

A separate business bank account for the company.

 

Own personal bank account.

Employment Status

Director

Employee of the umbrella company.

Expenses

 

Higher scope to offset expenses against the company’s tax bill.

More restrictive scope to reclaim expenses.

Feasibility

Not ideal for short-term contracts.

Good for short-term contracts.

Insurance

 

The company needs to pay for business insurances. (E.g. Professional Indemnity)

Insurance cover is typically included in the Umbrella fee

IR35

 

If caught, most of the tax benefits of being limited are lost.

Already taxed as an employee. IR35 is irrelevant.

Legal Duties

Directors have a number of statutory and financial duties.

No legal duties.

Multiple Clients

Profitable to cater to multiple clients.

Reduced efficiency – not ideal to work for several clients at the same time.

Payment/Invoicing

As a director, the contractor will invoice the agency for work done on behalf of the company.

 

Being an employee of the Umbrella company, the timesheet will be submitted to the umbrella company. The umbrella company invoices the agency.

Self Assessment

 

All company directors must complete an annual tax return.

No need to complete a tax return unless there is additional untaxed income in addition to the umbrella earnings.

Set-Up

Company Formation can be completed in a few hours.
– A specialist contractor accountant can help in a speedy set-up.
– Tends to be more tax efficient.

– Instant set-up with a contractor specialist.
– Easy and fast registration.

Tax Efficiency

 

The most tax efficient way to contract. No National Insurance (NI) is payable on dividends.

As an employee, the entire salary is taxed via Pay-as-you-earn (PAYE).

Tax Liability

As a Director, the contactor is responsible for ensuring that the company and personal taxes are paid on time.

The umbrella company deducts taxes before the salary is paid.

Tax Planning

 

Highly flexible as dividends can be timed to maximize use of lower tax bands.

Few tax planning opportunities are available.

Value Added Tax (VAT)

Joining the Flat Rate Value Added Tax (VAT) scheme can be profitable – including a discounted rate in the first year.

Value Added Tax (VAT) is collected by the umbrella, no extra benefit to contractor.

About the Author:

Sumit Agarwal
, A specialist accountant and tax adviser for freelancers, contractors and small businesses since 2005, He is an expert in business growth and development strategies. A renowned tax expert for owner managed businesses and contractors, He won the British Business Forum’s Young Entrepreneur Award in September 2012, presented at the House of Commons by MP Vrinder Sharma.