To work as a contractor, you typically need to operate through an intermediary, which is a company that sits between you and your recruitment agency or end client.
In this guide, we examine the pros and cons of the two main business structures: limited company vs. umbrella company.
Option 1: Work via your own limited company
How it works
If you set up a limited company, you typically earn a small salary and extract most of the company’s profits via dividends.
This is the most tax-efficient way of contracting, as dividends are taxed at a lower rate than a PAYE salary. You also don’t pay National Insurance contributions on dividends.
Tax planning advantages
You can split shares with your spouse and make other tax-planning decisions that aren’t available to umbrella employees.
Limited liability protection
As a limited company, your liability in the event of things going wrong is limited, and your personal and business finances are kept separate.
Limited liability is a key benefit of incorporating.
Director responsibilities
However, as a limited company director, you take on several important responsibilities. You have to:
Most limited company directors hire an accountant, which significantly reduces the administrative burden. This allows you to concentrate on your actual contract work.
If you sign up with a PAYE umbrella company, you become an employee of that company.
You sign a contract with the umbrella company, which then handles contracts on behalf of the agency or end client.
Once you submit your invoice or timesheet, the umbrella company invoices the agency, manages your payroll, and deducts all necessary taxes and fees on your behalf.
A hassle-free option
This is a ‘hassle-free’ solution that may suit many contractors.
Your umbrella company will pay you after deducting:
Pension contributions and any other agreed-upon deductions, such as student loan repayments.
IR35 has no impact
If your contract is caught by IR35, it doesn’t matter under an umbrella setup.
You already pay full PAYE tax and NICs, and IR35 is irrelevant.
Be cautious with marketing terms like “HMRC compliant” or “IR35 compliant”. These phrases don’t reflect any legal or tax advantage. All umbrella workers are taxed the same.
Choosing an umbrella provider
The main differences between umbrella companies are:
Do you want to run a business or prefer a ‘hassle-free’ solution?
Do you want control over your financial affairs?
How important is it to maximise your post-tax income?
Are your contracts caught by the IR35 legislation?
How long do you intend to contract?
Will your client or agency accept a limited company arrangement in the first place?
Overall guidance
If you don’t want to run a business, prefer to avoid administrative tasks, or plan to contract for a short time, an umbrella company is likely the better fit.
If you plan to contract long-term, want to maximise your income, and your work is outside IR35, then setting up a limited company may be the smarter route.
Recent changes due to Off-Payroll Working Rules (IR35 reform)
