Is an umbrella or limited company best for contractors?

Is an umbrella or limited company best for contractors?

Making the jump into contracting is a big decision, but it’s not the only one that you need to make. You also need to decide the structure that you will work under.

Making the jump into contracting is a big decision, but it’s not the only one that you need to make. You also need to decide the structure that you will work under.

  • With direct contracts, the contract exists between the client and either the contractor’s own limited company or an umbrella company.
  • Contracts can also be made via recruitment agencies. In this case, one contract exists between the agency and the client company. Another is made between the agency and the contractor’s limited or umbrella company.

As you can see, both scenarios can be used with either a contractor’s own limited company or an umbrella company, but what are the differences between these two ways of working?


Limited companies

If you decide to operate as a limited company, you will become your own company director. This is generally considered to be the most tax-efficient way to operate, but it also comes with a number of statutory regulations and obligations that you must fulfil. You will have to submit annual accounts to Companies House, commit to running the company responsibly (though that would be in your best interests anyway) and meet HMRC tax obligations.

While you are responsible for meeting these obligations, however, there are plenty of specialist contractor accountants who will be happy to do the legwork for you. You will have to pay them, of course, but the tax benefits could still outweigh these costs.

The reason why this model is so tax-efficient is because you can choose to pay yourself a relatively low salary and take other remuneration in the form of dividends. You do not have to pay NICs on these dividends, potentially resulting in a tax saving. It’s worth noting that the value of this tax saving has been dramatically reduced since new dividend tax rates were introduced in 2016.

There are some other tax benefits, however. As company director, you can choose when to withdraw funds. This can help in tax planning and, where appropriate, you might also be able to transfer shares to a spouse.

While you pay income tax and National Insurance on your wage, the business must pay Corporation Tax on all profits. VAT is also added to your invoices and repaid to HMRC – minus any legitimate VAT that you have already reclaimed on business purchases.

To start a limited company, you can register with Companies House yourself. This is a cheap and quick process nowadays, but many contractors still prefer to let their accountant handle the procedure, alongside other startup tasks such as setting up payroll and registering the new company for VAT and Corporation Tax.


Umbrella companies

Umbrella companies are becoming an increasingly popular option for UK-based contractors. When you sign up to this type of scheme, you essentially become an employee of the umbrella company. The end client or agency pays the umbrella company based on the weekly or monthly hours that you have worked. The umbrella company then deducts your income tax and National Insurance, any expenses and its own fees, and pays you the rest in the form of a salary.

This tends not to be as tax-efficient as operating under a limited company structure, but many contractors prefer it as it is regarded as more hassle-free. This can make it a good option for people who are only planning to contract for a limited time, who are testing the contracting waters, or who simply want as little paperwork and related obligations as possible.


The effects of IR35

One important piece of legislation that may affect your decision is known as IR35. This was introduced by the government as a means to crack down on so-called “disguised employment”, where a worker might enjoy the tax benefits of being self-employed while actually working in a way that is identical to an employee of the business that he is engaged by.

This legislation was first introduced back in 2000, but it was augmented by “off-payroll” changes introduced last April. This meant that public sector clients are now responsible for determining a worker’s status as regards IR35.

If your contract work is deemed to be subject to IR35, the tax-efficiency value of working as your own limited company is severely reduced. This could be another reason for considering the option of an umbrella company.

Please fill in the form below and someone will be in touch with you shortly.

*Required fields

Back to FAQs

Please fill in the form below and
someone will be in touch with
you shortly.

*Required fields

Privacy Policy