Umbrella vs Limited Company – Which is right for you?

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Due to the proposed changes in IR35, many contractors face a difficult decision of selecting either an umbrella company or a limited company to carry out their contracts. The goal for almost every contractor is to get the highest possible returns from their contracts. Which option allows them to reap the maximum benefits from their contracts depends on several factors.

Both types of companies have their advantages and disadvantages. For contractors facing the dilemma of choosing between the two, it is crucial to understand the benefits they will get from each of these options. However, it is also necessary to understand the differences between both options at a fundamental level.

What are Umbrella companies?

Contractors can join an umbrella company and be considered its employee. It allows contractors to connect with recruitment agencies and take several contracts on which they can work. Similarly, it helps provide them with a hassle-free way of dealing with both their clients and any related taxes that come due to the nature of their work. For contractors that are relatively new to the market, umbrella companies are one of the best available options.

Umbrella companies also help contractors in determining their IR35 status. Because contractors effectively work as employees of an umbrella company, they don’t get affected by the regulations set by IR35. Similarly, umbrella companies also help in this regard, by calculating and deducting the income tax and National Insurance Contribution (NIC) payments from a contractor’s earnings.

How do contractors get paid when working for Umbrella companies?

An umbrella company helps contractors get contracts through recruitment agencies. Once the company assigns a contractor to a specific contract, the contractor must complete and submit a timesheet for the hours they work. Similarly, contractors must keep track of the expenses they incur during their work, which they must submit and get approved. Most umbrella companies have online portals to facilitate this process.

Based on the type of contract, the umbrella company will invoice the recruitment agency either after regular intervals or at the end of the contract. The recruitment agency, then, invoices the end client. Some umbrella companies may also invoice the end client directly, skipping the recruitment agency in the process. 

Once the umbrella company receives the payment from the issued invoice, it processes the payment. Before paying the contractor their salary, the company makes some deductions through PAYE, such as tax and NIC. It may also include charges for other expenses and the fee or any agreed-upon charges. After these deductions, the company pays its contractor.

What are the advantages and disadvantages of Umbrella companies?

There are several advantages and disadvantages to umbrella companies in general. However, the advantages and disadvantages discussed below are in comparison with limited companies.

Advantages

An umbrella company takes care of its contractors’ tax and NIC payments, which they may have to do by themselves or hire someone to do for them. Most importantly, however, contractors working through umbrella companies don’t need to worry about their IR35 status, as the company takes care of all their PAYE payments. There are also various expenses that contractors, as employees, can claim, available here.

Similarly, by using umbrella companies, as opposed to limited companies, contractors can limit their liability when entering contracts. Umbrella companies enter a contract with recruitment agencies and, therefore, bear the risks associated with it. Similarly, contractors don’t need to worry about other responsibilities that come with limited companies, such as preparing financial statements, tax returns, auditing, etc.

Lastly, the process of joining an umbrella company is also straightforward. Contractors don’t need to go through complicated procedures, unlike when setting up their own limited company. All they need to do is find a preferred umbrella company and sign with them.

Disadvantages

While an umbrella company gives contractors some control over the contracts they work on, they still can’t control other aspects of the company, such as its policies or fees associated with contracts. The lower control also means that if the company fails or liquidates for some reason, contractors may end up losing their pending earnings or existing contracts.

As stated, umbrella companies take care of deducting taxes under PAYE. However, contractors still need to handle their personal taxes with which the company doesn’t help them. Similarly, while umbrella companies offer certain employment benefits under laws and regulations, they may charge contractors for providing these benefits.

Lastly, contractors may have several options available when it comes to choosing umbrella companies. However, some umbrella companies try to fraud or deceive contractors. If a contractor ends up in one of these companies, they may suffer not only the damages caused by the company but also be liable for any unpaid taxes.

What are Limited companies?

Limited companies allow contractors to convert their business into a company. By becoming the director of their own company, contractors can get better control over how they work and from whom they take contractors. Most contractors in the UK work through their own limited companies. Limited companies offer contractors autonomy, tax benefits and limit their individual liability, among other advantages.

How do contractors get paid in Limited companies?

Limited companies allow contractors to get paid through two different sources, which include salaries and dividends. Through these companies, contractors get more tax benefits as compared to umbrella companies. It can also help them save tax and NIC payments traditionally made under the PAYE system.

Contractors operating their limited companies can select any client with whom they choose to work. They can negotiate their contracts in a more beneficial way that increases their revenues. Similarly, in limited companies, contractors receive any payments directly from the client and don’t need to pay any processing fees, which they must when working under umbrella companies. 

Working as a limited company, contractors can pay themselves salaries and other tax-free expenses. However, they must also bear some added types of tax, such as the corporation tax, value-added tax (VAT), NIC on salary for employees, etc. Similarly, they can pay themselves dividends from the post-tax profits. However, they will need to pay tax on the dividends again as individuals.

What are the advantages and disadvantages of Limited companies?

There are several advantages and disadvantages of limited companies as compared to umbrella companies.

Advantages

The most important advantage of operating through a limited company is that it allows contractors to divide their income through several sources. It helps in tax planning and provides a more tax-efficient solution when it comes to retaining the maximum possible earnings. Similarly, limited companies allow better control of all company matters, allowing for even better tax planning. 

Contractors also get full control over their revenues when operating through a limited company. Unlike umbrella companies, they don’t face the risk of losing their revenues to frauds or scams. Furthermore, it allows them to get their payments faster, as compared to the complicated process for umbrella companies going through several parties.

Limited companies also limit the liability of contractors, separating their personal assets from their business assets. Contractors can also claim expenses through their limited company, a list of which is available here. Lastly, limited companies provide contractors with better control over which contracts they secure and allow better flexibility with how much they want to work. 

Disadvantages

Limited companies come with more administrative burden for contractors, as compared to umbrella companies. Operating through a limited company, contractors must ensure their company complies with all regulations that apply, especially taxation regulations. In case of non-compliance or being late, they may also have to suffer heavy penalties. Contractors also have to take part in managing and administrating the company, something they don’t have to deal with in umbrella companies.

Contractors working under limited companies face a higher risk of getting flagged by the tax authorities under the IR35 legislation. They need to provide proof that they are operating as an entirely separate entity to any organizations for which they contract. If contractors are found guilty of working within the IR35 and hiding it, they can face fines and penalties.

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