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As a contractor, you can set up a business as a limited company or opt to operate under a PAYE umbrella company. Deciding between the two, however, can be a challenge for many contractors; both present advantages and downsides, depending on your business and experience as well as how long you intend on contracting and how much time you want to spend on paperwork.

As contractor accountants, we understand just how important it is that you pick the right structure for your business, which is why we’ve put together a guide to help you make an informed choice.

What is an Umbrella Company?

The number of umbrella companies operating in the UK has grown over the past few years.

Contrary to when you set up your own limited company, you become an ’employee’ when you join an umbrella scheme. This means you’re neither the director of your own company, nor do you have the responsibilities that come with it. You receive a salary after tax, National Insurance and expenses have been deducted; there are usually other pre-agreed fees, as well as the fee you pay the umbrella scheme.

The umbrella provider takes care of all accountancy, administration and taxation matters, while you only need to complete a timesheet and forward it to the umbrella company, who then invoices the end client or agency on your behalf. You receive your payment once the client has paid the umbrella company. 

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Pros and Cons of an Umbrella Company

Just like with limited companies, there are several benefits to choosing an umbrella company as your business structure, including the following:

  • Short-term contracts – Umbrella companies are better options for short-term contracts, when you’re just starting out as a contractor and are unsure whether or not you want to own a business. After all, you don’t want to go through the costly and time-consuming process of forming a company only to have it dissolved after finding out it’s not for you. Therefore, this is a low-risk and temporary solution for those who are still testing the waters.
  • Hassle-free – if you don’t want to take on any form of administration or paperwork, umbrella companies are best-suited for you, as they offer a hands-off approach. This includes dealing with VAT returns, payroll matters and company accounts. Everything is deducted before you receive your money as well, so you can have the peace of mind of knowing that you have no further taxes to pay.
  • Time-saving – limited companies consume a lot of your time with the sheer number of administrative tasks that need to be performed accurately and on time; on the other hand, umbrella company schemes are quick and simple to use, as the company handles it all for you.
  • No self-assessment – you don’t have to complete a tax return form unless you earn untaxed income in addition to your earnings from the umbrella company.
  • No legal duties – as an employee of the company, you don’t have any legal duties to keep in mind. This can free you to focus on your job instead of having to worry about anything else.

There are also some disadvantages associated with choosing an umbrella company. They include:

  • Lack of representation – contractors are unable to represent themselves as they would if they were running their own business.
  • Higher costs – one of the main downsides of using an umbrella company is that it can be more expensive. Everything the umbrella company does for you – such as client invoicing or administration costs – will have an associated fee or a bulk fee.
  • Less control – you have to give up a lot of control when you join an umbrella company, as you won’t be running your own company; you’ll simply use the company as a service to process transactions, while someone else is in charge of all of your paperwork. While many individuals are perfectly fine with this, and even prefer it, others may not be. This is why it’s important to analyse both structures in order to make the right decision.
  • PAYE – contrary to owning a limited company, operating through an umbrella company will mean that you’ll be paying more tax and PAYE when using an umbrella company due to the Managed Service Company legislation.

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What is a Limited Company?

We start by defining what a limited company actually is. Simply put, if you operate through this structure, you become a company director, joining the ranks of approximately 1.8 million trading limited companies registered in the UK. A limited company is a separate legal entity that can be formed even if your business is a one-man band – as the director, you’re responsible for legal, financial and statutory decisions, submitting annual accounts to Companies House (the registrar of companies in the country) and you’re responsible for meeting your HMRC tax deadlines.

With a limited company, the company’s assets and liabilities are separate from your personal finances. This means you’re legally liable for its debts only to the extent of the amount of capital invested. You can pay yourself a salary and draw the rest in the form of dividends, which are not subject to National Insurance contributions, this will depend on individual circumstance.

Another important subject to consider when operating through your very own limited company is IR35. If you’re caught by IR35, you’ll lose most of the tax benefits of working as a limited company. You can read more about this regulation and how it affects you by checking out our recent article: ‘What is IR35 and why should you be aware of it?

Pros and Cons of a Limited Company

Because each case is unique, there are several pros and cons to operating through a limited company. It can be a challenge to know whether this structure is for you, so take a look at some of the advantages limited companies offer to see if it would apply to you and your business:

  • Tax-efficiency – limited companies can be the most tax-efficient structure, especially when compared to an umbrella company, in which your entire salary is taxed via PAYE. When working through a limited company, you will take home anything between 75% to 80% of your contract pay; if you opt for an umbrella company, this value is more between 60-65%. As a contractor operating through a limited company, you have access to the flat rate VAT scheme. Our take-home pay calculator can help you to find out how much you’d take home as a limited company owner.
  • Flexibility – you have a great deal of flexibility by operating through your very own limited company.
  • Control – limited companies offer more control, given that the director of the business controls all the transactions, the invoicing, the salary and dividend amount, and the bank account. You don’t have to deal with third parties to get your income, as is the case if you choose umbrella companies. A contractor accountant can easily help you deal with this aspect of running your very own limited company.
  • Faster payment – because you have direct control, payment and administrative processes are faster; that is, of course, if all transactions are dealt with efficiently.
  • Limited liability – because limited companies are separate legal entities, your personal assets are always protected. Should the company suffer financial difficulties or have to close, you don’t have to worry about your personal assets being taken to pay outstanding debts.
  • Long-term contracts – limited companies are the best choice if you’re considering taking on long-term contracts.
  • Professional image – owning a limited company conveys a more professional image, which can be extremely helpful in certain contracting fields.
  • Easier to claim expenses – you can also claim a wider range of expenses. These include costs that you incur while running your business, like equipment or business travel. You must be able to clearly outline all of your expenses as the director of a limited company. 

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While there is a world of benefits in choosing to operate through a limited company, there are also some disadvantages, such as the following:

  • Suited for higher paying contracts – if you are working lower-earning contracts, an umbrella company may be more suited for your business.
  • More paperwork – one of the main downsides of choosing a limited company is the amount of administration and paperwork that can arise; this is especially true when it comes to late filings or payment penalties. Not only can this become a hassle for many company owners, but it also takes up a lot of their time.
  • Increased responsibility – directors are in charge of everything; while that gives them a great deal of control, it also means they have a responsibility to keep on top of day-to-day issues like invoicing, ensuring all forms are filed correctly by their due dates and more.
  • Need for accurate records – when you own a limited company, you need to take care of all administrative duties that come with running your own business, such as keeping accurate records of goods that have been purchased and sold, information of any debts the company may have, details or all incomings and outgoings and assets owned by the business.
  • Lack of privacy – for many, this is one of the major disadvantages of doing work through their limited company. After all, as the director of a limited company, you have to submit details to Companies House, which will become public record, meaning anyone can access them. You do have the option to use a registered office address, as offered by Gorilla Accounting.

Umbrella or Limited: Which Company is Right for You?

The simple answer is, it depends. Each case is different, so your decision to set up your own limited company or join an umbrella company is contingent upon how you want to conduct business and with whom.

While you may have little control over your business with an umbrella company, you don’t have as much paperwork and administrative matters to handle, such as chasing payments and negotiating with clients. This type of business structure is likely the best option, if you are new to contracting and are still unsure whether it’s what you want to do long-term.

If you want to work with several clients and are confident that you’ll want to continue contracting, then a limited company is best-suited for you. You may have more administrative tasks to take care of, but you also have a lot more control over your company. By being the director of your own limited company, you’ll also be able to structure the way you pay yourself.

Before making a decision, it’s crucial that you seek professional advice. We specialise in providing accountancy for freelancers and contractors operating through a Limited Company or Umbrella Company.  

What’s more, at Gorilla Accounting we also ensure that you get services with no extra charges or hidden fees; you only have to pay a one-set fee. Letting us take care of everything as you grow your business means more peace of mind for you.