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Umbrella vs Limited Company

Deciding to enter the world of self-employment by becoming a contractor is an exciting decision. However, it is also a decision that comes with a lot of responsibility. Self-employed individuals have all of the same tax reporting obligations as salaried employees, plus the additional responsibilities of being business owners... There is a lot to think about. From a tax perspective, there is the question of working under an umbrella company or establishing a limited company. Which is better for contractors?


The origin of the umbrella company dates back to 1999 legislation commonly known as IR35. This legislation was enacted to prevent companies from dismissing salaried employees at the end of one week, then rehiring them the following week as contractors – to save both parties money. That legislation left a void for contractors who still wanted to be independently employed without having the full responsibilities of running a business.


Proponents of limited companies insist that running one's own business is not extremely complicated, and we would agree, especially when contractors work with experienced accountants. As a speciality accounting firm focusing on contractors and limited companies, ICP provides clients with the administrative support required to handle finances and comply with all regulatory requirements. Having said that, we want to explain why we believe the limited company is advantageous over the umbrella for tax purposes.


Employment Status


The first thing to consider in the umbrella versus limited company question is employment status. Under the law, a contractor working under an umbrella is a paid employee of the umbrella scheme. That means the contractor is not truly independent. The umbrella 'hires' the contractor, generates all invoices to clients, receives all payments for services provided, and pays contractors for their work. The umbrella also handles all of the tax and National Insurance issues as well. All of this costs money that comes out of the pockets of contractors.


Creating a limited company establishes the contractor as a director of that company. The contractor is still responsible for individual taxes, just as he or she would be as a salaried employee of another company; the limited company pays corporation tax and collects and pays VAT as well.


This may appear a break-even scenario when you consider the limited company director pays income tax, and the company pays corporation tax. Nevertheless, as we will show you in just a moment, establishing a limited company is actually more tax advantageous. The structure of a limited company allows directors to take home more of their pay, legally we might add, with a lower tax liability and none of the fees and charges that come with working under an umbrella.


How Contractors Get Paid


One cannot ignore how contractors are paid when talking about the tax advantages of limited companies. As previously stated, those working for umbrellas are paid by the umbrella scheme, fewer taxes and administrative fees. One example of how this might work would involve an umbrella company charging a client £20 per hour for services but only paying the contractor £12. Right away, the contractor is not earning his or her full potential.


The contractor invoices the umbrella for the services rendered; the umbrella pays the contractor minus taxes and National Insurance due under the PAYE scheme. The average take-home pay for a contractor is about 60% to 65%. Nonetheless, remember, that is a percentage of what the contractor invoiced the umbrella for. It does not account for the extra money the umbrella earns from clients.


The contractor with his or her limited company is paid differently. First, he/she is paid a minimal salary as an employee of the company. That salary is subject to income tax and National Insurance. The remainder of the contractor's pay comes as dividends earned by the company. Dividends are not subject to National Insurance, saving the contractor a significant amount of money. The average contractor with a limited company enjoys take-home pay of between 75% and 80%.


Accountancy Firm Services


We have worked with numerous clients who were fearful of establishing limited companies because of all the paperwork involved. Limited companies must:


  • register with HMRC and Companies House
  • register for VAT and PAYE
  • collect and submit VAT on a regular schedule
  • deduct and submit PAYE contributions
  • file regular paperwork for tax purposes.


It is no secret that the UK has one of the most complex tax regimens in the world. It is understandable that contractors would be fearful of setting up limited companies and running afoul of the law. However, that is where an accountancy firm such as ICP comes in. Our flat rate service charges a low annual fee to handle all of these things for you.


What We Do for Clients


Our accountancy services for contractors begin with filling out and submitting all the necessary paperwork to establish a limited company. Included with that paperwork is our ongoing commitment to handling all interactions with both HMRC and Companies House on your behalf.


We register our clients for both the VAT and PAYE, regularly advising them when payments are due and how much needs to be paid. We prepare all of the annual paperwork necessary for both the limited company and a single director. That paperwork includes tax returns. Finally, we advise our clients on the best ways to make their businesses more tax advantageous. Best of all, our services do not end here.


ICP provides our clients with a customised software platform that makes day-to-day accounting easy. With our app, contractors can upload and keep track of all business expenses throughout the tax year. We use that information to help calculate tax liability. Contractors can invoice their customers and keep track of revenues with the app as well.


Contact ICP for more information about setting up a limited company. As a contractor, you can run your business and take home more pay by establishing a limited company and working with ICP for your accountancy services.

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