Limited Company Vs. Umbrella Company Guide for UK Contractors

Deciding to become a contractor is a big decision. You are leaving behind the routine and security of permanent employment. But, for those who are brave enough to do it, the benefits more than often outweigh the risks.

Finding the contract may be the easy part, but knowing how to operate as a contractor, may be harder.

Typically, you will find that there are two options available to you. These are to operate via your own limited company or to go through an umbrella company.

Which route is best?

Well, firstly, let’s look at what they both are.  An umbrella company (no they don’t sell umbrellas) is effectively a middleman, between you as a contractor and the client (this can be the end employer or a recruitment agency) and are responsible for handling your payment.

Now, let’s focus on a limited company. A limited company is a company that you set up to run your business (which is you working as a contractor). You then register as a director of the limited company and receive payment through a salary and dividends.

So, now we know more about the routes you can take. Let’s discuss the pros and cons of each.

Umbrella Company

Choosing to work through an umbrella company is in the short-term easier than setting up and running your own limited company. When you register with an umbrella company, in effect you sign a contract of employment with them. The umbrella company then invoices your client / agency for the work you have done. The umbrella company then pays you, minus Income Tax, National Insurance and fees.

Working via an umbrella company means you have less paperwork to fill in (only paperwork to fill in is timesheets and expenses form) then if you were contracting via your own limited company. You will receive more take home pay than if you were employed as a permanent member of staff but not as much as somebody who is operating via their own limited company.

Limited Company

Deciding to contract via your limited company isn’t something that you should jump straight into. Before setting up the company there are many things to consider; firstly, you are doing it for the right reason (i.e. you will not use it as a vehicle to avoid paying tax) and secondly, do you understand the legal requirements of owning a business and understand what taxes you and your company have to pay.

There will be more paperwork involved, for instance: registering the details with Companies House, opening a separate bank account for your company, nominating a director for your limited company (this is normally yourself) and issuing shares.

Many contractors engage the services of a specialist contractor accountant, who will handle most of these things for them. Going forward, you should expect to spend 15-20 minutes each month on paperwork.

Operating via a limited company allows you claim more things as expenses, and also gives you access to the Flat Rate Scheme, which was designed to simplify the claiming of expenses.

On the plus side, with greater responsibility comes greater take home pay, you can expect to take home around 75% of the overall contract value.

Summary

In conclusion, if you are serious about contracting and see it as a long-term option, then contracting through your own limited company makes more sense, particularly when it comes to tax. Every contractor wants to work in the most tax efficient manner and contracting through your own limited company is the best way to achieve this.