Limited or umbrella company – which is best for contractors?

If you want to become a contractor, you must work via an intermediary in most cases. This is a company which sits between you and your agency or client.

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 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 don’t pay  National Insurance contributions on dividends.

You can also split shares with your spouse and make other tax-planning decisions that aren’t available to umbrella employees.

As a limited company, your liability if things go wrong is limited – and your personal and business finances are separated. Limited liability is a key benefit to incorporating.

However, as a limited company director, you take on a number of responsibilities which you need to be aware of.

For example, you must maintain accurate company records and update Companies House with any changes. You must also keep accurate accounting records, submit your tax returns on time and pay any tax you owe by the deadlines.

If you hire an accountant—as most limited company directors do — this significantly reduces your administrative burden. This will allow you to concentrate on your contracting work.

The biggest problem many contractors face is dealing with IR35.

This tax legislation seeks to tax individuals working via their own limited companies if their work is more akin to that of an employee than that of someone in business on their own account.

If your work is caught by IR35, you will pay more tax, and there are few advantages to working via a limited company.

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 another 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 employment costs, personal tax and NICs and any other agreed-upon deductions, such as their monthly fee (margin) and pension contributions.

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

Some umbrella companies claim to be “HMRC compliant” or “IR35 compliant.” These are just marketing phrases—there should be no difference in the way contractors are taxed between umbrella companies.

The main ways to differentiate between the benefits provided by umbrella providers are customer service, reputation, monthly costs, and any ‘extras’ offered to clients, such as free insurance.

Read more in our umbrella company section.

Which is best – limited or umbrella?

Generally speaking, 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 enjoy 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 legislation?
  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 only expect 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 contracting option.

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.

Recent changes due to the Off Payroll Working rules

Unfortunately, you may not have much choice due to the Off-Payroll (IR35) rules, which came into force in April 2021.

This change means that clients are tasked with determining the employment status of their contractors. If they miscategorise a contractor as being ‘outside IR35,’ they face financial penalties.

As a result, many clients no longer hire limited company workers and may insist that you trade via an umbrella company.

Seek professional advice

So, make sure you consider both routes from a personal and financial point of view, and if you need help – 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.

Find the best accountant/umbrella to use

Visit our directories to browse some of the leading service providers:

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Last updated: 14th March 2024