Many contractors contract via limited companies as this is the most tax efficient way to operate, especially if you are not caught by the punitive IR35 rules.
Other contractors who don’t want to deal with any paperwork, are contracting for a short period, or are caught by IR35, may prefer to contract via an umbrella company – as this represents a “hassle free” way to contract.
So, what are the advantages and disadvantages to incorporating a company?
Advantages of limited companies
- Contracting via a limited company is more tax efficient than working via an umbrella company. Limited company contractors typically take a small salary (minimising PAYE and NIC liabilities), and withdraw the remainder of their income in the form of dividends. NICs are not payable on company dividends.
- If caught by IR35, the benefits of incorporation are much reduced, but you may still benefit from joining the flat rate VAT scheme, and using the 5% expenses allowance. You will need to check your eligibility with your accountant.
- Having a company will be advantageous if you have other business interests and wish to present a ‘professional’ image of your enterprise.
- Your personal liability as a director is limited, as the name suggests, if things go wrong. One exception is if you are asked to personally guarantee a bank loan to the company.
- As a director, you are in complete control of all company affairs, both financial and administrative.
- You can create different share classes, which can be useful for tax-planning purposes, to attract investors (if you diversify your business), or to divide ownership between a number of people.
- Limited company owners can control the way they remunerate themselves. You can choose the optimum split between salary and dividends, and decide when to draw income from the company.
- As a limited company is a legal entity in its own right, it can be sold, or passed on to future generations with ease.
- If you sell your company (however unlikely for the typical contractor) and have accumulated funds within it, you may be able to benefit from the Entrepreneurs’ Relief scheme, via which you pay a mere 10% in CGT on share sale proceeds if you have owned the shares for a year or more.
Disadvantages of limited companies
- Running a company involves more administration than working via an umbrella company (although typically your accountant will take most of this burden away from you).
- There are some costs associated with running a company, such as company filing fees, accountancy costs, stationery, and one-off legal and administration costs.
- Each year, your company will need to file Annual Accounts with HMRC and Companies House, and complete a Confirmation Statement (previously the ‘Annual Return’).
- As a company director, you are ultimately responsible for ensuring that your accounts have been prepared accurately and are submitted on time – even if these tasks are carried out by your accountant.
- If you provide contract services via an ‘intermediary’ (your limited company), then the IR35 legislation could apply to relevant assignments if you have not taken appropriate action to comply with the rules. The financial consequences of being caught by IR35 are significant.
- The limited company route may not suit someone who is planning to take on a short-term contract.
Read the second article in the series, looking at the advantages and disadvantages of contracting via an umbrella company.
If you want to set up as a limited company contractor, try one of our specialist contractor accountants who can help you get started.