Limited or umbrella company – which is best?

If you’re a contractor providing professional services to clients, you will need to trade via an intermediary – either your own limited company, or via a third party payroll provider (an umbrella company).

Here we look at the pros and cons of each business structure – limited vs. umbrella company.

Option 1: Work via your own limited company

If you set up a limited company, you will typically draw a small salary, and take most of your income in the form of dividends.

This is the most tax-efficient way of contracting, as dividends are taxed at a lower rate than a PAYE salary, and no National Insurance contributions are payable on dividends.

As a limited company director, you will take on a number of legal responsibilities. You must ensure that you comply with administrative and financial deadlines demanded by both Companies House and HMRC.

If you hire a good accountancy firm, they should deal with most of these responsibilities on your behalf. However,  you are ultimately responsible to ensure that your company accounts, Confirmation Statement, quarterly VAT returns, and other documents are submitted to the correct authorities accurately, and on time.

If your contract is caught by the IR35 legislation, then you will have to draw your income down via a deemed salary (subject to standard rates of income tax).

If your contract work falls under the IR35 rules, you may still be at a slight tax advantage to umbrella company employees, but this has become less likely as a result of April 2017 and April 2021 tax changes.

And, if you have very low quarterly expenses – ‘a limited cost trader’, there is no longer be a tax advantage to be had by joining the Flat Rate VAT scheme.

Read more in our limited company section.

Option 2: Work via an umbrella company

If you sign up with a PAYE umbrella company, you become an ’employee’.

You sign a contract with the agency, and they sign the contract with the agency or client.

After you submit your invoice/timesheet to the umbrella company, the umbrella invoices the agency and takes care of all tax and administrative paperwork for you.

This is a ‘hassle-free’ solution which may suit many contractors.

Your umbrella company will pay you after deducting income tax (PAYE), National Insurance Contributions (NICs), and any other agreed deductions – such as their service charge (margin).

If your contract is caught by IR35, it makes no difference to an umbrella company contractor, as you are already paying full PAYE and NICs on your earnings.

Some umbrella companies say that they are “HMRC compliant” or “IR35 compliant”. These are just marketing phrases – there should be no difference in the way contractors are taxed between different umbrella companies.

The main ways to differentiate between the benefits provided by umbrella providers are in terms of customer service, the fees charged, and any ‘extras’ offered to clients, such as free insurance cover.

Read more in our umbrella company section.

Which is best – limited or umbrella?

There are five key factors to take into account when choosing which company structure to use:

  1. Do you want to run a business, or do you want a completely ‘hassle-free’ solution?
  2. Do you want to be in control of your financial affairs?
  3. How important is maximising your post-tax income?
  4. Are your contracts caught by the IR35 rules?
  5. How long do you intend to contract for?

If you do not want to run a business or deal with any company administration, or you are only expecting to contract for a brief time, then setting up a limited company is probably not for you. An umbrella company can provide you with a hassle-free way of contracting.

If you are set on contracting for some time, want to maximise your income, and your work isn’t caught by IR35, then the limited company route is probably right for you.

Unfortunately, you may not have a great deal of choice in the matter, due to the Off-Payroll (IR35) rules, which came into force in April 2021 (delayed from April 2020). Many clients, unwilling to take on the risk associated with hiring contractors under the new rules may insist that you trade via an umbrella company.

So, make sure you consider both routes from a personal as well as financial point of view, and if you need help – make sure you consult a specialist accountant or other professional adviser first. They will be able to further explain the pros and cons of each company structure and provide you with an income projection based on each scenario.

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Last updated: 15th October 2022