How to set up as a Limited Company Contractor

The most popular way to start up in business in the UK is as a sole trader.

So why do IT contractors avoid this route, and work via their own limited companies or via umbrella schemes?

So, what is a sole trader?

The easiest way to set up a business in the UK is as a sole trader (or as a member of a partnership). After informing the tax authorities that you are about to, or have recently become self employed, you can start trading without of the constraints associated with running a limited company.

However, as a sole trader, your liability if things go wrong is unlimited (unlike the limited company route), and your personal and business finances are treated as one for tax and liability purposes.

Why won't agencies deal with sole traders?

Even if you wanted to set up as a sole trader, you would be unlikely to find a recruitment agency who would be prepared to do business with you.

You can either become a PAYE employee of the agency, or form a relationship via your own limited or umbrella company.

Although you are legally entitled to work as a sole trader, you would probably only be able to work directly for clients who were happy to engage you on that basis.

Here are the key reasons why this is the case:

1. The Income Tax (Earnings and Pensions) Act 2003 (and related pieces of legislation) do not allow 'self employment' in this situation, as the recruiter would be obliged to make the contractor an employee, with the associated taxation and employment burden this would place on the agency.

Chapter 7, Section 44 of the Act states:

"all remuneration receivable under or in consequence of the agency contract (including remuneration which the client pays or provides in relation to the services) is to be treated for income tax purposes as earnings from that employment."

2. As a result of 1. the recruiter (or end client) could be liable if a self employed contractor defaulted on his or her tax obligations to HMRC.

3. Importantly, as a limited company contractor director, a contractor is afforded some financial protection if things go wrong, whereas the sole trader's personal assets can be seized if money is owed by the business.

This final point is perhaps the strongest reason for steering away from the sole trader route if you want to become an IT Contractor, even if the prevailing legislation allowed it.