Umbrella Company Vs Limited Company

 In Contractors & Freelancers

As a contractor, you may choose to work through an umbrella company or set up as a limited company. Here’s how you can decide on the best option for you.

When you become a contractor, one of your first choices will be how to structure the way you work. Do you go fully independent and set up your own limited company or do you work through an umbrella company? Both have their advantages and disadvantages as well as reporting obligations.

Umbrella company

The number of umbrella companies in the UK is rising as we move towards a more freelance-orientated economy. This can be seen as as a half way house between fully independent contracting and full-time employment.

On the one hand it is not nearly as tax efficient as setting up your own limited company or working as a sole trader, but it involves much less work and can be a good idea if you’re looking to test the waters.

With this option, you will become an employee of the umbrella company but you will not receive a guaranteed monthly income. Instead, your client will pay the umbrella company when you have submitted your invoice. They who is they? will then pay you a salary after they have made deductions for national insurance, income tax and pensions contributions. The umbrella company may also charge a fee which comes out of your pay.  

It is similar to a payroll service, handling all your administration, processing invoices and timesheets. You should also be able to reclaim all legitimate business expenses from them unless you are deemed to be under the supervision, direction or control of your client (SDC).

This is an option for people who want to minimise the work and hassle of contracting, but on the downside, the chances are you will see less of each client’s invoice at the end of the month. As well as being less tax efficient, you’ll also be charged a fee for working with them.

Umbrella companies have also come in for some negative headlines over the years. For example, one scheme left its contractors facing potentially enormous tax bills from HMRC. They made advance gross payments which were taxable at a later date but packaged these up as bonuses without informing the contractors about their nature.

Such unscrupulous operators are in the minority, but it pays to be sure the company you work with is credible and will be working with your best interests at heart. There are things you can do to protect yourself. For example, a search with a credit agency will show whether the company is financially sound. A more general internet search may also reveal any problems other contractors may have.

You should make sure you have a clear employment contract rather than a looser collection of terms setting out what the umbrella company will do for you. You will be a full employee of the umbrella company with all the rights and protections which come with it, so make sure this is guaranteed with an employment contract. It can also help to get expert advice.

Limited company

A limited company is a more comprehensive option. It is more tax efficient and gives you greater control over the way in which you work. You’ll be able to pay yourself an income in a lower tax band and take the rest as dividends. As long as corporation tax is set at a lower rate than income tax it will also save money. On the downside, it does come with additional work and reporting obligations.

Once you set up a limited company, you will need at least one director and shareholder. You can fulfil both roles, but you may add additional directors or shareholders if you want to bring other people into the company. At the same time, you will be an employee of the company and can pay yourself a regular salary.

You can set this at a rate which reduces your tax exposure. So, for example, you could keep your salary in a lower tax bracket, while also paying yourself a dividend. This is not subject to National Insurance so should save you some money.

You can also choose when to take income out of the company which gives you much more freedom and flexibility than when you’re working through an umbrella company.

The hard work comes in administration and paperwork. You’ll become one of around two million actively trading companies in the UK and this brings with it a number of statutory filing obligations.

You’ll have to register with Companies House. To do this, you need to find a name which isn’t taken. This could present a problem if someone has already registered your name. One way to avoid this could be to set up a dormant company. You register this company and make basic filings to Companies House, but it doesn’t do any business. It keeps your name and domain ready for the moment when you decide to start it up. When that happens you simply notify HMRC.

You’ll also have to file annual accounts, meet all HMRC deadlines and run your limited company responsibly. If you do decide to expand and take more people on, you’ll have all the same responsibilities to them that your old employers had for you. In other words, you’ll have to put them on payroll, manage PAYE and meet your statutory obligations as an employer.

The process of registering with HMRC is quick, simple and only costs £12 if you register online. In most cases, your new company will be registered within 24 hours. Even so, some people prefer to use third parties such as accountants to manage the paperwork for them. Indeed, using an accountant can be a good way to manage all your administrative responsibilities. They can manage your finances and ensure you’re meeting all your filing deadlines. This not only keeps your finances up to date and in decent working order, but it allows you to concentrate on doing your job and expanding your client base. It means you spend more time deploying your skills in the most profitable ways.

Making your choice

Both options come with their benefits and drawbacks. On the one side you might want the easier option of working with an umbrella company, but on the other you may look for the control, flexibility and tax advantages of a limited company. In many cases, one can follow the other. If you’ve been thinking about making the move from full-time employment into freelance or contracting work you could dip your toe in the water with an umbrella company. Once you’re ready to move forward, you can then take the next step and set yourself up as a limited company. In either case, a little help from the experts can be immensely valuable.

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