Limited Company vs. PAYE Umbrella

When delving into the world of self-employment, there are so many new things that you need to think about. However, your first step is deciding what business structure to start trading under. The key question usually comes down to: Limited or Umbrella? 

 

Umbrella

Limited Company

Self Employed

Two different types of NI

Probably no NI

Only one type of NI

Taxed as PAYE

Lower and more flexible tax

No control over timing tax

Limited Expenses

Expenses allowable

Expenses allowable

Maybe as low as 65% retention

As high as 85% retention

As high as 75% retention

Low risk

Low risk

Low risk

No admin (except for timesheets and expenses log)

Some admin (choose your accountant well)

Some admin (choose your accountant well)

 

A limited company

This is a legitimate company, which is formed and filed at Companies House. Upon setting up the company, you will have to open up a business bank account and sign on as a company director. There are about 1.3 million companies registered in the UK and each company director must meet a whole host of statutory and financial obligations. These include ensuring that the company is run responsibly, submitting accounts and annual returns to Companies House, plus all the tax obligations to the HMRC.

It was believed that running a limited company was difficult and there are mountains of paperwork. However, there are plenty of contractor accountants who can manage the handling of your business for you. Here at Contractor Unlimited, we can be with you every step of the way to ensure a smooth running of your business. 

An umbrella company

An umbrella company is a standard UK limited company, but a third party operates it. It acts as an employer and you, as the contractor, are like an employee of the umbrella scheme. As an ‘employee’, you submit timesheets to the umbrella company and they will then invoice the client for the work done. They then process all the necessary paperwork and pay you a salary, minus deductions for National Insurance, Income Tax, possible pension payments and any admin fees that the umbrella company charges.

The contractor is not a company director and the umbrella company will handle all the admin, so paperwork will be kept to a minimum. You will not be responsible for any financial accounts.

Advantages and Disadvantages of a Limited Company Structure

Setting up your own limited company and trading under that is generally the most tax efficient way of working. As a contractor/director of the company, you get complete control of your money. You can pay yourself a basic salary and then the rest in the form of dividends. These dividends are not subject to National Insurance Contributions and therefore you will save a significant amount of money on tax. You also have a lot more flexibility as you can take money out of the company whenever you want to. This in itself has tax benefits. Shares can also be transferred to a spouse (if applicable). With an umbrella company, your salary would be transferred into a third party bank account, thereby increasing the transaction time.

Another major benefit of a limited company is the amount of expenses you can claim back. A limited company can claim back a much wider range of expenses such as. Not only can they claim the usual travel and subsistence but also money spent on accountancy fees, equipment and software, plus professional subscriptions and training. They will also have access to the Flat Rate VAT scheme, allowing them to claim back some of the VAT charged to their company.

Don’t forget all the other benefits of having a limited company; you have limited liability, meaning that you have legal and financial protection should anything go wrong with your business and also you will have more borrowing power. Limited companies have a separate pool of money to borrow one, which is separate to your individual borrowing power.

The only real downside to creating a limited company is the amount of paperwork that needs to be done. You are legally obliged to file annual returns and company accounts. If these are not done, the director can be liable to serious fines and other penalties.

It is also not a good idea to start a limited company if you think you are only going to be contracting for a short period of time. If you are in between jobs and planning to go back to employment, then the tax benefits do not outweigh the hassles of having a company.

Advantages and Disadvantages of an Umbrella Company

The benefits of using an umbrella company are very clear; you do not have to worry about a single bit of paperwork apart from handing in your timesheets. Everything is taken care of for you – no company accounts, no tax returns. Your NI contributions and income tax is immediately taken out of your paycheques, so you don’t need to worry about paying future taxes at a later date. Your money will also come straight to you as if you are an employee – you will not need to worry about dealing with invoices and processing transactions. There are also no fees connected with setting up a limited company either; this is particularly good if you are only contracting for a short period of time.

However, the disadvantages of using an umbrella company can be costly. The amount of income tax and NI taken out of your wages is quite hefty. You are also subject to admin fees from the umbrella scheme. Often, they will insist on a minimum fee for using their services and this can get rather costly – sometimes up to 9% of your contract. If you compare this to a full accountant’s fee of £1200 per year, regardless of turnover, you can see which one is more worthwhile.

You will also have to wait for a lot longer for payments to be processed as they will be transferred into a third party bank account. This means that the contractor has no control over his finances, or the company, as he is not a director.

One thing that might fool you when it comes to umbrella companies; there are many myths that they have special schemes that allow you to claim back expenses without any proof of spending or you can claim back more money if you use their services. This is completely untrue. You will only ever be allowed to claim expenses for items that are purchased – this is determined by UK tax law and not on the company who pays your salary.

So…Limited or Umbrella?

Therefore, you have some things to think about when starting out as a contractor. It seems that, in order to maximise your income, forming a limited company is the way to go. Figures show that you will take home approximately 75-80% of what you earn, compared to when using umbrella services, where 60-65% of earnings are taken home.

However, each individual’s needs are different and that is why we are here to help. Feel free to speak to any of our contractor accountants today who can advise which option is best for you.