Contractors Options – Umbrella vs Limited Company
What is the best option to contract through, an Umbrella Company, or a Limited Company?
In a fast-paced economy, skill shortages can create huge bottlenecks for businesses and their projects. Contractors are considered a typical solution to such problems, coming in for short periods they are contracted to fill the resource gap, with their required skill set. A contractor performs a specific job after signing a contract, which can be long term or short term. They have the choice to work in the private sector or the government sector depending on their past experiences. Having the opportunity to work with different companies by moving from one contract to another, contractors gain valuable experience and expertise whilst doing so, and can add value to projects utilising the skills acquired. If you are thinking about becoming a contractor read our guide on how to become a contractor.
Why you should work as a contractor?
There is no limit to progression and what you can achieve when you are working for yourself.
You should encourage yourself to become a contractor if you love to take challenges, have an entrepreneurial spirit and can handle pressure without disrupting any other aspect of your life. You should be ready for the flexibility, security and independence it offers. This independence can allow you to be more creative and efficient in your work. You can maintain a good work/life balance because you will have more manageable meetings to attend, can work from home and can take out time for your personal and social life.
You can earn income from multiple sources as you take on different contracts and switch from one contract to another, gaining valuable expertise and experience whilst doing so. You will be able to enjoy high wages if the skills you possess are in high demand in the market. Contracts will generally offer you a higher degree of control over your tax planning but also increases the risk and responsibility you face. If you are undecided about if you should become a contractor or not, why not speak to a competitive contractor accountant who should be able to help you with all your questions.
Though working as a contractor has its own perks and benefits, you will also be responsible for meeting the deadlines in a timely manner, updating your expense records, and managing your taxes. At the end, you will be answerable to yourself and the tax man and will be responsible for your own success or failure.
Types of contractors in the UK:
Contractors can work for the private sector and government sector both. There are different types of contractors, working in their respective fields. Following are the types of contractors in the UK:
General building contractors:
General contractors are involved in construction and renovation projects and can cover anything from repairs and maintenance, window fittings, plumbing to other more general building works. They can be an organization or an individual.
IT contractors provide services to businesses which are highly dependent on technology by giving technical expertise to enable them in optimizing and managing information for business processes.
These contractors provide transport services to institutions and entities. They may provide bus services to schools or transport services for employees working in different sectors of the economy, these can also be truck or lorry drivers working for logistic companies, etc.
Individuals or businesses that offer contractual services to other contractors, they may be responsible partially or fully for an entire contract.
Consultants are contractors who provide solutions in the form of professional advice to different areas and domain. They may be legal consultants, financial consultants, economic consultants, etc.
Locums are doctors working on a contractual basis and provide services by temporarily fulfilling the duties of other doctors who are absent from duty, they usually provide services to short-staffed hospitals.
Difference between an Umbrella Company vs Limited Company
In some situations, a firm might require temporary services and for this purpose, they may hire temporary employees because hiring permanent employees will not be feasible. They hire such employees through an umbrella company, such companies act between the employer and the client. The umbrella company bills the client collects the payment and finally pays the contracting worker or firm. It effectively acts as an outsourced employer, contributes to national insurance, pays taxes and is fully licensed to manage payrolls. These companies due to the nature and time of their services are beneficial when working for a short-contract instead of a Limited Company Route.
In a limited company, contractors become the shareholders and directors which means that they are the owners and managers of the company. This brings with it not just the responsibility of performing one’s contract duties but also the responsibility of running the company effectively. An Ltd is a separate entity to its owners and is responsible for its own finances which differ from personal finances and has its own rights and requirements. Shares are issued in exchange for a shareholder certificate which gives the shareholder ownership in the LTD and as a result, profit generated through the company will be divided among the shareholders as dividends according to the per cent of shares invested. Contracting through a limited business company requires managing payroll and taxes on your own and is suitable for long-term contracts, which means the work involved in managing the company and its taxes increases however also increasing the room for tax planning and extracting funds as efficiently as possible. The solution to utilising a Limited Company for contracting is to find and hire competitive contractor accountants, they will be able to save you time, guide you and help you plan effectively for tax.
Does IR-35 apply to umbrella companies?
IR-35 also known as intermediaries legislation is a piece of legislation that came into effect to tackle the problem of tax avoidance by taxing those considered as “disguised employees”, and to guide contractors on if they should be considered as employees or contractors when working on a contract and what kind of taxes they are liable to pay based on their employment status. HMRC’s CEST tool has been created to help employers and contractors determine their employment status for tax purposes to avoid future issues.
IR-35 is not applicable to umbrella companies due to the way they are structured and the way they tax contractors. An umbrella company operates payroll and taxes the income of contractors under PAYE, therefore, umbrella companies are not at risk of coming within IR-35. You need to make sure that your umbrella company is not using any schemes which can come under the loan charge or tax avoidance schemes as flagged by HMRC. If you have been picked up under the loan charge scheme, speak to an accountant, an accounting firm, tax accountants or someone suitably qualified immediately. Read more about loan charge here.
Advantages & Disadvantages of an Umbrella company for contractors:
-Umbrella handles the paperwork, deducts taxes and national insurance before the contractor gets paid saving them time and effort.
– It is responsible for tracking and recording all of its transactions while the contractor just has to submit expenses information and timesheets on a monthly basis to the company.
-The contractors working on short term contracts and taking less than £25k are better off working with an umbrella company in order to avoid the compliance hassle that comes with running a limited company.
-Your income gets taxed at source, therefore, you do not have the benefit of planning the most efficient way to extract your earnings.
– Income is subject to taxes and national insurance, it means that the take-home pay will be less (60 to 65%) than if they were to go through a Limited Company.
Advantages & Disadvantages of a Limited company for contractors
-Within a limited company, contractors have full authority to manage their financial activities and transactions, giving them more control over their money.
-Contracting through a limited company can help contractors keep more of their income as it is the most tax efficient option (75% to 87% take home pay)
-The limited company offers extensive tax planning opportunities for contractors which can be beneficial. Speak to your contractor accountants to learn more.
– Setting up a limited company comes with company filing fees, accountancy costs and a one-time legal administration cost which can become too much for some individuals, and if the contracting idea is a short term one it is better left to be done through an umbrella company.
– Limited company shareholders face a lot of administrative challenges in running a limited company.
– The contractor is responsible to record and complete all of their paperwork and the paperwork for the company, this can get time intensive, costly and overbearing.
– You are responsible for invoicing, billing, timesheets, mileage logs. More responsibility means more stress and pressure.
Tips on selecting an umbrella company:
Selecting an incorrect umbrella company can result in incorrect payroll submissions, getting stuck with tax avoidance schemes or getting inefficient extractions. The price you end up paying due to an incorrect selection can become huge, so it is very crucial for you to choose an umbrella company after thorough research and proper planning. Speak to a suitable contractor accountant before going down the umbrella route, as they could make the process so simple and easy that you might avoid going down the umbrella route.
“Tip 1: Select an umbrella company that is well-connected and established, has references and is approved by the agency you will be working through. Ask the umbrella for any penalties or fees they might charge for leaving early, ask the agency you are working with for recommendations. If the umbrella seems too good to be true it probably is.“
A well-reputed umbrella company will help you focus on your contract work without any hassle or problems while offering you high wages and benefits through an efficient PAYE structure. Our contractor accountants can help you select a suitable umbrella company if that is something of major concern.
“Tip 2: Use an umbrella company that offers a user-friendly portal:“
Under an umbrella company, the contractor has to submit timesheets and expense information on a monthly basis. It is advised you go with the umbrella companies who offer user-friendly portals so that you will not be bogged down with admin work.
“Tip 3: Make sure there is no ‘pay when paid’ clause in the contract:“
You should check the past payment history of the umbrella companies, whether their previous contractors were paid on time or not. You should get paid within a reasonable time after submitting your timesheets.
“Tip 4: Make sure you are working under a full-term contract of employment:“
Before signing up, one should check if the contract being offered is full-time or not. As you sign the contract, you become an employee of the umbrella firm. As an employee, you are entitled to legal statutory rights and benefits in the UK under full-time employment.
Tips on setting up an LTD for contracting
“Tip 1: Set up a unique company name:“
Brainstorming to come up with a unique name is totally worth it, never name your private limited company with sensitive words or phrases. Name your company, according to the services you are offering, this will make your LTD look more professional.
“Tip 2: You need to issue an invoice“
Invoice your client to receive payments for the services you have provided as a contractor. You need to provide your name, details about your company, invoice date and vat number, you will also need to provide your client’s name, address and details about the products and services offered to the client. If you are unsure about how this works, our fully trained in-house contractor accountants will be able to help you setup effectively and will be able to guide you in relation to all aspects of running your limited company.
“Tip 3: Hire a support professional:“
It is recommended that you hire a virtual assistant or an administrative professional who will look after the administrative and HR issues of the company. As a stakeholder and a director in a limited company, you have to make sure that you have enough resources to perform the administrative duties required by the company to avoid any penalties. Speak to your accountant to see if they provide VA support before finding and hiring a virtual assistant.
“Tip 4: Consult a professional accountant:“
It is highly recommended to consult a professional accountant from an accountancy firm, as you will require professional support in running your company. Through proper tax planning, accounting and compliance your accountants in London can mitigate tax liabilities, discover the benefits of flat rate VAT schemes and makes sure that you fulfil your financial and legal obligations on time and correctly.
“Tip 5: Register your company at an official address and not at your residential address.“
Make sure the registered office address is in the respective territory in the UK, that is if you register a company in Wales, then the office address should be in Wales too. The same rule applies for individuals who plan to register their companies in other states in the UK (England, Scotland and Northern Ireland).
Working as a contractor is rewarding because you are able to gain valuable experience, expertise and can earn income from multiple sources as you move from one contract to another. You also have increased flexibility and the contract rates are higher compared to if you were employed.
But there are also risks when contracting so before signing up, you need to conduct thorough research on why you want to contract, the potential for contracting in your field, the tax benefits and the trading structure you would want to adopt.
You need to first check whether your contracting goals are in alignment working either under an umbrella company or a limited company. You must identify the purpose of your contractual services, the value these services held in the target market and the trading solution that will be optimal for the nature of the contract, short term or long term.
Based on the potential earnings, the administrative challenges, paperwork, the ease of managing taxes and how quickly you get paid, you should be able to decide whether to opt for an umbrella or a limited company.
Competitive Contractor accountants will be able to guide you in staying compliant with the rules and regulations. They will also be able to help you in identifying the major differences between umbrella companies and limited companies. It is safe to conclude that contractors can reap maximum benefits, if they examine the advantages and disadvantages related to working with umbrella and limited companies, and inspect whether their interests align with the best option.
Clear House Accountants are professionally trained and specialized Accountants in London. Our in-house team of accountants consists of a large number of contractor accountants who have been trained for years. Our contractor accountants will help you to create smart and the most tax-efficient solutions so that you can save money and extract the maximum possible amount safely and effectively. Contact us to see if we can guide you with our expertise.
Anam has a degree in accounting from the Prestigious St John’s University, and works as a senior director in Clear House.
Before working in Clear House, Anam worked in various commercial roles, the last one being the VP Operations for a prestigious business organisation,working on improving the organisation’s operational efficiency, growth and high level client management.
Anam manages clients ranging from software companies to large property developers and managers. Notably, she recently worked with a large property development company building large scale developments in London and the surrounding area.