As a contractor one of the first decisions you need to make is how to structure your business. The two main options are to set up your own limited company or work through an umbrella company. The umbrella company vs limited company debate is a hot topic and often the first real decision for aspiring contractors. There are benefits to both business models and it’s important you understand the pros and cons of both to ensure you pick the one that’s right for you so you get the most out of it
What is a limited company?
A limited company is a separate legal entity through which you conduct your business. As it’s a separate legal entity to yourself, the company has its own bank account and assets. Contracts are between your business and your client, and any profits and losses belong to the company.
Factors to consider when choosing a limited company:
Operating as a limited company has immediate tangible benefits and gives you more control and flexibility over your business. While it involves additional administrative responsibilities, it also offers potential financial advantages. Consider the following aspects:
- Tax efficiency: A limited company structure provides opportunities for tax planning and optimisation. By paying yourself a combination of salary and dividends, you can potentially reduce your overall tax liability. it’s important to note that these tax benefits of a Limited company disappear if you fall within legislation called the Intermediaries Legislation – commonly known as IR35. If your working arrangements put you on the wrong side of IR35, you’ll pay tax and National Insurance at the same rate as a normal employee
- Professional image: Establishing a limited company can enhance your professional reputation. Clients often perceive limited companies as more established and credible, which may open doors to higher-paying projects and long-term contracts.
- Administrative burden: you will still need to keep track of your income and expenses, including receipts and invoices, and provide the information required for the submission of your year-end accounts and tax return.
What is an umbrella company?
An Umbrella company acts as an employer for contractors on temporary contracts, typically working through a recruitment agency.
Factors to consider when choosing an umbrella company:
An umbrella company is a popular choice for many contractors due to its simplicity and convenience. When you work under an umbrella company, you essentially become an employee of the company, with all your contracts and payments managed by them. Here are some important points to consider:
- Tax and National Insurance Contributions (NICs): As an employee of the umbrella company, your taxes and NICs are automatically deducted from your income. This relieves you of the responsibility of calculating and paying taxes on your own, ensuring compliance and peace of mind.
- Administrative ease: With an umbrella company, you don’t have to worry about managing administrative tasks such as invoicing, bookkeeping, or filing annual accounts. This allows you to focus solely on your freelance work
- Employment rights and benefits: As contractors sign a full contract of employment with an Umbrella company, they’re entitled to the full statutory benefits of employment – Statutory Maternity and Paternity Pay (SMP/SPP), Statutory Sick Pay (SSP), a pension scheme and holiday pay. Many Umbrella companies also offer additional employment benefits such as insurance, private medical cover.
- Starting up: Umbrella companies are suitable if you’re working on a short-term contract, or unsure if you’ll continue contracting long-term. Unlike a Limited company, which needs to be closed down if it’s no longer needed, you can simply end your employment with an Umbrella company if you no longer require their services.
Making the decision
Deciding between an umbrella company and a limited company is a significant choice for contractors. The decision should be based on factors such as your financial goals and long term plans. For short-term contractors, an umbrella is a sensible solution, rather than going down the more time-consuming route of setting up a new limited company.
