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Umbrella vs Limited Company – What You Need To Know

Umbrella vs Limited Company – What You Need To Know

If you are starting out as a contractor then there are a number of decisions that you need to make especially concerning how you are going to manage your finances. There are a number of options open to contractors regarding this, but the two most common are either setting up a Limited Company or working under a PAYE Umbrella Company.

There are both advantages and disadvantages to each of these options and which you choose is likely to be governed by a number of factors; such as the length of time that you are expecting to be contracting for, how much you will be earning and the amount of paperwork and financial responsibility that you are willing to take on.

Limited Company

Operating as a Limited Company involves setting up a specific company, with you as the director and shareholder.

This will allow you to handle the way in which you get paid from the company in the most tax efficient manner possible. For example in this situation many people will choose to pay themselves a relatively small salary (usually under the personal tax and/or National Insurance threshold) and receive most of their income in the form of dividends which are taxed at a lower rate than a PAYE salary and upon which National Insurance contributions are not required.

However operating as a Limited Company will mean that you have to take on the responsibility for ensuring that the company is correctly set up, all paperwork is handled correctly and all submissions are done so correctly and before the deadlines. There are a number of specialist accountants who will be able to handle most of these requirements for you; however you will need to factor their fee into your costs and also remember that, as the director of the company, you are still ultimately responsible for all the administrative and financial responsibilities of the company.

Advantages of a Limited Company

Depending on your circumstances there are a number of advantages of operating as a Limited Company:

  • This is the most profitable and tax efficient way of working, especially if you employ mechanisms such as tax efficient dividends. You can also control when you take money out of the company or transfer shares to your spouse, both of which can have advantageous tax results. Generally through a Limited Company you can expect to keep between 75%-80% of your pay.
  • You have complete control over your company, including all revenue and transactions.
  • If your Limited Company is set up correctly then you will be able to claim back a wider range of expenses; including accountants’ fees, equipment and software costs, and other general business expenses.
  • You may have access to the Flat-Rate VAT Scheme, where you pay a fixed amount of VAT to HMRC and are then able to keep the difference between the VAT that you charge your customers and that which you pay to HMRC.
  • You have the status of a company director, which can be advantageous in some industries.
  • Limited Companies are generally suitable if you are earning over £300 per day and are expecting to contract long term.

Disadvantages of a Limited Company

Although a Limited Company may feel like a tempting solution, there are some circumstances where it could actually be disadvantageous:

  • If you are only contracting for a short time between periods of employment then going through the process of setting up a Limited Company generally isn’t worth it.
  • Even with the assistance of a specialist accountant there is still an amount of paperwork that needs completing and compiling by the company director, and this may be off-putting for some people.
  • Limited Companies are generally not suitable for people who are earning less than £25,000 per annum.
  • If you are caught by IR35 then the financial advantages of being a Limited Company can become negated.

Umbrella Company

Operating through an Umbrella Company means that you are effectively an employee of a separate company who pays you directly, handling all of your tax and NI responsibilities through PAYE. This company will then invoice the contracting business or agency for your time, as you submit timesheets.

This is essentially a hassle free way of contracting as the Umbrella Company takes care of all of the paperwork; however you will receive less of your pay than with a Limited Company as you will be paying higher levels of tax and National Insurance and will also be paying a service or management fee to the Umbrella Company.

Advantages of an Umbrella Company

There are a number of advantages of contracting through an Umbrella Company, which can include:

  • This is a hassle-free way of contracting, leaving you with peace of mind that all of your tax and NI obligations are being fulfilled. Some umbrella companies will also provide pension plans and any specific insurance policies that may be required. All of this can be provided with absolutely minimal paperwork on your part – other than submitting weekly or monthly timesheets and your expenses.
  • Using an Umbrella Company is ideal for short term contracts as you don’t have the hassle and expenses of setting up a Limited Company and then arranging for it to be dissolved again.
  • If your contract is likely to be caught by the IR35 then using an Umbrella Company is sensible as you would end up paying a similar amount of tax through a Limited Company anyway, and would have the added hassle of having to administer the company.
  • Umbrella Companies are also recommended if you are expecting to earn less than £25,000 per year, as below this figure the tax advantages of operating as a Limited Company are mainly negated.
  • This can be a good solution for people just starting out contracting, and you can easily choose to ‘resign’ from the Umbrella Company and set up your own Limited Company at a later date.

Disadvantages of an Umbrella Company

Some contractors may find that working through an Umbrella Company is disadvantageous for some of the following reasons:

  • You will take home less of your pay due to the higher levels of tax and National Insurance contributions that you will pay, along with the Umbrella Company’s fee – typically you will take home between 60%-65% of your total earnings.
  • You are reliant on the Umbrella Company to collect your money and then pass it on to you in a timely and correct manner. Most Umbrella Companies are very proficient, however if anything does go wrong you have very little control over the situation and could be left out of pocket.
  • By using an Umbrella Company you don’t have any control over your finances and do not have the ability to act as, or the status of, a company director.

Whichever route you choose then we would recommend getting the advice of a specialist accountant, as they will be able to further examine your specific circumstances and then offer expert and impartial advice as to which would be the best option for you.

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David Tattersall
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Hi there - I'm David from Handpicked Accountants. If you need help finding the right accountant, simply give me a call. My expertise is in connecting business owners with the very best professional services and I'm on hand to assist you today.

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