Contractors and freelancers in the UK are commonly faced with two options when choosing how to operate: umbrella company vs limited company. Our latest article provides an overview of an umbrella company and a limited company, plus the advantages and disadvantages of both options to help you determine which option you are better suited to.
Umbrella company vs limited company
When choosing how to operate, contractors and freelancers in the UK are typically presented with two options: either an umbrella company employee or a limited company director. The preferred option for independent contractors and freelancers in the UK is to establish and run a limited company. This is because it is the most tax-efficient option to operate, as directors have more control over their operations, finances, and tax planning options—provided their assignments fall outside of IR35.
However, not every contractor feels up to the administrative duties that come with holding the position of director of a limited company. Therefore, you can use an umbrella company if you would rather have fewer administrative duties or work on assignments that fall inside IR35. Using an umbrella company for your payroll is an incredibly easy option, as once you’ve completed registration, all you need to do to get paid is submit a timesheet.
Some recruitment agencies offer the option to get paid via agency PAYE (the agency’s payroll) for inside IR35 assignments. While all agencies don’t provide this option, if you’d prefer it, look for agencies that can process your payroll.
Whichever path you decide to choose is ultimately up to you. However, to remain compliant with IR35, if you are inside IR35, you must be paid via Pay As You Earn (PAYE). Your income tax and National Insurance Contributions will be deducted at source by the fee payer, and a net payment will be paid to you when you are due to be paid. You cannot be paid gross for contracts that are inside IR35. Therefore, an umbrella company could be a more beneficial choice for inside IR35 assignments. We’ll go into more detail about both choices, their benefits and disadvantages below.
Limited company
Personal Service Company (PSC) is not legally defined; however, it refers to a limited company in which the sole or main shareholder simultaneously serves as the company’s director. If you decide to follow this route, your limited company provides professional services to end clients, perhaps through an agency.
What are the benefits of a limited company?
A limited company is a separate legal entity, which means the company’s finances and liabilities are kept entirely separate from your own. Your personal assets are always protected, and you are only liable for the amount you put into the business should it face financial difficulties.
For contractors operating outside IR35, a limited company is the most tax-efficient route, as you can pay yourself a combination of salary and dividends. Trading through a limited company means you can claim a variety of business expenses as long as they are incurred wholly and exclusively for the purpose of trade. You can deduct some of these costs to reduce your taxable profit as long as they’re allowable expenses.
Once you register your company with Companies House, your name is protected by law, and no one else can trade under the same name. Suppliers and customers often have more confidence in limited companies, as they are deemed to have more credibility, as incorporated companies are more rigorously monitored.
What are the disadvantages of a limited company?
As a director of your own limited company, you will be responsible for all aspects of the company’s administration. This includes strict record-keeping, invoicing, calculating and paying taxes to HMRC and complying with UK tax laws. You must file annual accounts with HMRC and companies house yearly and complete a confirmation statement.
As your company is registered on Companies House, any information you are required to provide, such as records, company annual accounts, and details of directors and shareholders, is a matter of public record that can be viewed by anyone.
Are you looking for a contractor accountant?
If you are looking for a contractor accountant, we’ve created a directory of contractors. Every contractor accountant in our directory is accredited by either the FCSA (The Freelancer and Contractor Services Association) or Professional Passport. While our directory is a great place to start, it’s important to carry out due diligence on a business before committing to its services.
Umbrella company
Recruitment agencies or end clients often use an umbrella company to pay their temporary workers. The umbrella company will employ you and pay your wages through PAYE – HMRCs system to collect tax from wages. Although the umbrella company is your employer, your work will be completed for the end hirer. Working via an umbrella company is one of the simplest ways to operate as a contractor. If you use a compliant umbrella company, you will have no unexpected tax bills in the future, as the correct tax will be deducted each time you are paid.
What are the benefits of an umbrella company?
- Compliance with UK tax law—Compliant umbrella companies will pay you via PAYE, and all tax deductions will be sent to HRMC on your behalf. You’ll be paid per UK tax law and HMRC regulations.
- Compliance with IR35 – If you use a compliant umbrella company for your assignments, all payments are subject to PAYE, and you will be paid a net amount (after tax deductions).
- Continuity of employment – Using an umbrella company allows you to work for multiple end clients and still have one employer – the umbrella company. Your tax code won’t be negatively affected, and continuity of employment is beneficial if you are trying to get a mortgage or loan.
- Employee benefits – You will have access to statutory employment rights, including Sick Pay and Maternity/Paternity Pay. For more information, please visit the government’s website.
- Minimal administration – There is very little administration when you use an umbrella company. Your umbrella company will take care of the majority of the administration, such as invoicing your agency or end client and processing payments and tax deductions. All you need to do is submit a timesheet each week/month.
- Umbrella companies are not expensive – An umbrella company margin is a much cheaper option than an accountant. Umbrella margins vary between providers but typically range between £15 – £30 per week, much less than you would expect to pay for an accountant.
- Simple registration—Registering with an umbrella company is very straightforward. You can register over the phone or via an online form in under 10 minutes.
- No tie-in period—When you use an umbrella company for your payroll, there are no joining or leaving fees and no tie-in period, and you are free to use them and leave them as you please.
What are the disadvantages of an umbrella company?
- All income is subject to PAYE – A limited company director can choose how to pay themselves, usually through a combination of salary and dividends. However, umbrella companies will pay you via PAYE. You’ll be required to pay Income Tax and National Insurance, which will be deducted before a net payment is made to your personal bank account.
- Not as tax efficient as a limited company – A limited company director can pay themselves with a combination of salary and dividends. In contrast, an umbrella company will deduct PAYE and National Insurance from your salary. Most umbrella employees can expect to retain around 50% – 70% of their pay.
- Reliance on third parties to be paid on time – The umbrella company can only process your payment once they have received the funds from your recruitment agency or end client. If there is a delay in the umbrella company receiving a payment, unfortunately this means there is a delay in you being paid.
- Tax avoidance schemes – Unfortunately there are a significant number of umbrella companies claiming to be legitimate and targeting contractors. Sadly, they are operating tax avoidance schemes designed to reduce your tax liabilities to HMRC. Contractors employed by these schemes will face massive tax billing and severe penalties in the future once HMRC discovers they are using or have used one.
For more information about the advantages and disadvantages of using an umbrella company, please click here.
Top 10 umbrella companies
Whether you choose to set up your own limited company or operate through an umbrella company, we must stress how important it is to use a compliant provider and not use a tax avoidance scheme. Using an FCSA-accredited contractor accountant or umbrella company will give you complete peace of mind that you comply with HMRC regulations and UK tax law. Another accreditation to look out for is Professional Passport or the SafeRec certification.
If you are looking for a compliant provider, why not take a look at our top 10 umbrella companies? You are absolutely not obligated to use their services, and it is a great way to chat with some industry experts about your payroll options.
