Understanding Limited vs Umbrella Companies

Which business structure is right for you?

The Benefits of a Limited Company vs Umbrella Company

When you become self-employed, a key early decision will be what business structure you operate under. Typically the most popular structures are limited company, sole trader, a partnership or operating through an umbrella company.

The business structure you choose has wide ranging implications including the amount of tax you pay, the level of control you have, your accounting and reporting obligations and the level of financial risk you face. For many, including the majority of our clients, running a limited company is regarded as the most appealing option because of the considerable benefits it offers such as tax advantages.

However, working through a limited company is different from working for an umbrella company and it’s essential to consider all factors to decide if a limited or umbrella company is the best fit for you.

At Gorilla, we like to help our clients make an informed decision on the best structure for their business. Below, we have provided a comprehensive limited vs umbrella guide including the advantages and disadvantages of both structures.

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Umbrella Companies vs Limited Companies – What’s the Difference?

The overarching difference is that when you contract through your own limited company you are self-employed, and when you contract through an umbrella company you are employed by them.

A limited company is a business structure where the company is a separate legal entity from its shareholders and directors. The shareholders and directors are protected by limited liability which means their personal assets are protected and their liability is limited to the amount of capital they have invested in the business. The business must be registered with Companies House and can keep any profits that it makes after tax.

There are many benefits of working through your own limited company and this makes it a popular business structure for self-employed people.

Limited Liability means Reduced Financial Risk

A limited company is a completely separate legal entity from its owners. This means there’s a clear distinction between business and personal finances and the directors and shareholders aren’t personally liable for any debts incurred by the company. This provides protection of personal assets as they can’t be pursued by creditors if the business encounters financial difficulties. The liability of the business shareholders is limited to the amount they have invested into the company.

Increased Tax-Efficiency

Working through a limited company provides significant scope to leverage tax planning opportunities which you don’t have when working through an umbrella company, or personal ownership. A limited company is the most tax-efficient business structure for self-employed people as you have full control over your remuneration. With the right structuring through a combination of salary and dividends, significant tax savings can be made whilst remaining compliant.

Claim a Wide Range of Expenses

As a limited company owner, you can claim on a range of allowable expenses that have been incurred wholly and exclusively for the running of your business. Examples of allowable expenses include the purchase of computer equipment, travel costs, accountancy fees, training, pension contributions and more. Allowable expenses are deducted from your company income before corporation tax is calculated which can result in a lower tax liability.

A Strong Company Image

When you operate through a limited company, your business is viewed more favourably by clients, suppliers and investors. Credibility is higher for limited companies with the business structure projecting an image of stability and professionalism that you won’t get when working through an umbrella company. In certain sectors, companies will only engage with other limited companies so being incorporated can give you a competitive advantage.

Limited companies are more strictly monitored and regulated and because information on the company and its Directors and Shareholders is publicly available on Companies House, they benefit from greater accountability and transparency. This public disclosure can also be viewed as a disadvantage for those that wish to protect their privacy.

There are set up costs involved with forming your limited company and you’ll need to register it with HMRC and Companies House. Once up and running you’ll have to spend more time on admin as you have the responsibility of filing your accounts and calculating and paying your taxes. Regulation is stricter and you might face fines or penalties should you not ensure tax compliance, although appointing a contractor accountant can be a help in mitigating these disadvantages and ensuring you maximise your take home pay.

An umbrella company is in effect an employment intermediary that you, as a contractor or freelancer, work for. When you operate through an umbrella company, you are their employee and will sit inside IR35. You will submit timesheets to the umbrella company for the work you have completed and the umbrella company then has responsibility for invoicing the end client or agency and paying you and you’re taxed at source through PAYE.

Simplicity

One of the main advantages of operating under an umbrella company is the simplicity this structure offers. Typically, you would just need to submit your timesheets weekly or monthly detailing the work you’ve completed as well as any expense details and then wait to be paid and the umbrella company handles the rest for you.

Working for an umbrella company means you receive employment benefits that you wouldn’t get from your own limited company such as statutory sick pay, holiday pay and maternity/paternity pay but limited company owners can mitigate this risk by taking out relevant business insurance to protect them should they be unable to work through illness, for example.

You Spend Less Time on Admin

An umbrella company will handle admin tasks such as maintaining financial records, processing timesheets, claiming expenses, invoicing and getting you paid. You also don’t have to worry about tax returns or compliance as that is handled through PAYE meaning you can focus more time on your work, but you don’t benefit from the tax advantages a limited company offers.

The simplicity and reduced admin obligations offered by umbrella companies mean that they offer a temporary solution for people looking to test the waters of contracting, or that are planning on contracting for a short time without having to set up a limited company.

You’ll Pay More Tax

Umbrella companies limit your opportunities for tax planning and optimisation. You’ll pay taxes like a conventional employee through PAYE meaning you can’t benefit from tax-efficient remuneration strategies such as utilising dividend payments or claiming expenses. This means that you’ll likely take home less than if you operated through a limited company.

Costs can be High

As well as paying more tax, you will also have to pay fees to the umbrella company for their services including additional fees such as administration fees, which would usually be deducted from your earnings before tax. This can make working for an umbrella company a more expensive way to operate your business.

Often contractors can find themselves in a situation where the end client they are working with deems the engagement to fall inside IR35. In this scenario, it is common for the end client to offer two options – to operate via a limited company, inside IR35, or to operate via an umbrella.

It is important to note that operating using an umbrella is not the same as operating inside IR35, although it is similar – it is effectively a substitute for operating via a limited company on an inside IR35 basis.

Contractors will wonder on whether there are any benefits to operating inside IR35 as opposed to umbrella, given the take home pay will work out roughly the same in either scenario.

Each situation is different, however, generally if there is a potential need for an accountant or if there is a plan/scope to operate outside IR35 in the future then there may be scope for small tax savings, and small savings on the cost of an accountant.

Generally a limited company structure offers the most benefits for self-employed people but everyone’s circumstances are different so you need to consider factors such as how long you want to contract and how much capacity you have for administrative duties.

If you plan to work on multiple projects with different clients over the long term, a limited company is best suited for you. You’ll have complete control over your business and will likely be able to earn more as well.

Before making a decision, it’s a good idea to seek professional advice from a specialist contractor accountant. At Gorilla, we are experts in providing accountancy for limited company contractors and freelancers and those operating through an umbrella company. We can advise on the best operating structure for you and with our limited company accounting package, all your business and personal accounting needs will be expertly handled by your own dedicated accountant.

How can Gorilla Accounting Help?

With the increased administrative responsibilities that limited companies have, you may find yourself paying more money in accountancy fees.

If you would like more information on choosing the right option for you, please get in touch as soon as possible.

At Gorilla Accounting, we ensure you only pay one set fee which includes no extra charges. You’ll also receive full guidance from your accountant should you struggle with any aspect of running your own limited company.

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