Explaining the difference between a Limited Company vs an Umbrella Company

We understand how daunting it can be for a contractor to grasp all of the legal, financial and fiscal aspects of starting and running a new limited or umbrella company.

The first question you need to ask is what structure will be right for your new contracting business? A limited company or an umbrella company? And what is the difference?

We can help you decide which structure will be the most tax efficient and serve your needs best. This post aims to explain:

  • What a limited company is?
  • What are the advantages and disadvantages of limited vs umbrella company?
  • What does the IR35 legislation mean?
  • What are the benefits of contracting?

There are many aspects that need to be considered when you decide to start your own company and at TaxAgility, we understand how complex it can be to navigate through all of the legal and financial requirements. We are here to help and assist in guiding you through initial set-up all the way through to on-going management. You will find we provide professional services with competitive pricing and offer targeted advice that will add value to your business.

If you have decided that a limited company is right for you, then the next step is to understand the scope of what is required, both to set one up and for on-going management.

Limited companies are quick and easy to set up, however they can seem overwhelming when you begin investigating your options, so we have summarised a number of simple steps to illustrate all that is required – from how to set up a limited company to ongoing management and contractor tax advice.

What is a Limited Company?

It’s a common enough question, but asking what a limited company is can bring about some very technical answers. There are a number of considerations to take into account for somebody looking to set up a new company when performing services as a contractor, and here at TaxAgility, our Accountants will help to assess the relevant legal and tax implications that you need to be aware of before setting up your own limited company.

A limited company is a company that has its own legal entity and is therefore treated as a separate tax-payer. Essentially, this means that the company’s finances are separate from the personal finances of the owners (shareholders) for tax purposes.

For contractors, a limited company often represents the most tax-efficient method for maximising your take-home pay. Under this structure, your income (and that of any shareholder) is channelled through a combination of salary and dividends, which can result in significant tax savings due to the nature of dividend pay-outs. The tax advantages are reliant on IR35 legislation, however, and whether you fall within this categorisation will determine your eligibility for these benefits.

In a legal sense, the creation of a limited company also has significant advantages for shareholders who are afforded ‘limited liability’, meaning they are only liable for the amount they have invested in the company and are not held responsible for the company debts incurred in the ordinary course of business, unless they are found guilty of misconduct. A Limited Company can be large with multiple employees or set up for just one individual as the sole director of the company.

Expenses

As a contractor, your limited company’s contract agreement can either be with the end client or an agency, and both of these options provide for a number of tax-free expenses that can be claimed through the company, including travel, business telephone, hardware and software, professional subscriptions, training, accountancy fees and other business costs.

Take home contract earnings

On average, working through a limited company can result in you taking home somewhere in the vicinity of 75 to 80% of your total contract earnings.

There are however a number of on-going administrative burdens and legal requirements associated with running a limited company, such as correctly invoicing your clients and managing the monthly payroll in addition to the various annual returns. For this reason, the majority of contractors opt to outsource their financial workload to a qualified accountant.

We can assist you with the initial set-up and ongoing management of your limited company for a competitive set monthly fee and with no hidden charges. Please contact us today for a complimentary no obligation meeting to allow us to maximise your tax savings and create the right structure to suit your individual circumstances.

What is an Umbrella Company?

Choosing to use an umbrella company to run your business can have a number of advantages, with the balance between autonomy and avoidance of many of the administrative duties commonly associated with running a limited company a big reason for their popularity.

Essentially, in this structure, you will be ‘employed’ by the umbrella company and will submit time-sheets and expenses to the umbrella company, who in turn will manage all of the administrative burdens for you, for a monthly fee (usually a percentage of your earnings). The umbrella company will draw up and distribute invoices to your clients, follow up on payments and calculate your tax and National Insurance. You will then be paid the net amount directly to your bank account as a PAYE employee of the umbrella company.

On average, working through an umbrella company could result in you taking home 60 to 65% of your total contract earnings. Though this could potentially be less than what you would earn under a limited company structure, the amount of financial and fiscal responsibility that you are burdened with is far less.

For individuals who are new to contracting or are working under a short-term contract, using an umbrella company is an easy way to enter the contracting market, however fees charged by umbrella companies vary considerably and can be substantial. For those contractors who are entering a long-term contract or are looking for the best possible returns, a limited company may be the better option.

If you would like to discuss these options further or to assess the best option for your individual circumstances, please contact us.

What are the advantages and disadvantages of limited vs umbrella company?

If you are a first-time contractor, it can be difficult to identify whether a limited company or umbrella company structure is right for you. We have summarised the key differences and pros and cons for each below and would be happy to discuss these in more detail as well as advise on other potential structures to maximise your tax savings.

Limited Company – Pros

  • The most tax efficient method to maximise your take-home pay
  • Straightforward to operate – you simply manage your accounts through the OpenBooks Online Accounting system
  • A wider range of expenses can be claimed, which are deducted from your tax contributions thereby increasing your take-home pay
  • Greater opportunity for tax planning than via a PAYE umbrella company

Limited Company – Cons

  • There is some administration involved in running a limited company, even with an accountant supporting you (approximately 10-15 minutes of paperwork a month)
  • It can be costly to set-up if you only plan on contracting/consulting for a short period of time, so is generally more suitable for long-term projects.

Umbrella Company – Pros

  • Very easy to use – you simply complete and submit your timesheets and expense claims
  • All tax and NI is deducted by the umbrella company, so you will receive a net salary and have no further taxes to pay
  • No time-consuming administration as the umbrella company manages this on your behalf
  • Best suited to individuals who are new to contracting or for short term contracts

Umbrella Company – Cons

  • The monthly fee charged by the umbrella company can be substantial
  • There is far less independence for contractors working under an umbrella company
  • Your salary is subject to full PAYE Tax and NI – essentially you are treated like a ‘permanent employee’ in the umbrella company

First consultation is free

We believe that in order to add value, we first need to understand your business and your needs. So, we offer our first consultation free to allow us to learn about your company and your personal financial circumstances and create an accounting solution to suit you.

Please contact us today regarding your limited company requirements, on 020 8108 0090 or complete the enquiry form and we will call you back.

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