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Essentials you need to know before becoming a contractor

August 4, 2016

Making the decision to go it alone and leave the relative security of life as a PAYE employee is a big one, but it can pay dividends (quite literally) when it comes to your potential earning power.

If you’re thinking about whether becoming a contractor could be the right career move for you, we have put together this guide to cover the key things you need to know before you make the move.

If you want to become a contractor, the good news is that there are plenty of different roles available, with everything from IT specialists and engineers, to management consultants and even locum doctors engaged on this basis.

The advantages and disadvantages of life as a contractor

The benefits for every individual will be different depending on the role, their location and what they’re looking to achieve in their careers. However, as a general guide, these are a few of the potential advantages and disadvantages of becoming a contractor;

Advantages of becoming a contractor

Greater flexibility

As a contractor, you can choose where you work, what contract you take and even if you work at all. If you finish a six month contract and have the money behind you to take a month off, you can.

Earn more

Not only do contractors typically receive good rates of pay, but there are also potential tax benefits that can increase your take-home pay.

Develop a broader range of skills

Working as a contractor allows you to work in a variety of contract roles for a wider range of companies and industries. This will help you build a broader range of skills and experience, and allow you to find the type of work you really love.

Disadvantages of becoming a contractor

More homework

Life as a contractor is not all frothy cappuccinos and lunchtime paninis. If you set up as a limited company (which we will discuss in the next section) you will have a number of accounting and tax obligations you will have to meet.

Reduced job security

With greater flexibility comes reduced job security. Depending on their terms, contract roles can be removed with much shorter notice and without the redundancy pay long-term employees can expect to receive.

No guarantee of finding more work

When one contract ends, there’s no guarantee that you will slip effortlessly into another. In some cases, it could take weeks or even months to find another contract role.

Limited company v Umbrella company

The reasons for choosing to become a contractor are unique to each individual, and it is often these same reasons that dictate whether contractors are better suited to setting up a limited company or operating under an umbrella company.

Limited company

A contractor who wants to maximise their earnings will typically choose to set up a limited company due to the tax efficiencies associated with this structure.

This will give you complete control over the business and your bank account. However, there are additional duties associated with this kind of structure, such as accounting, tax and other obligations.

Umbrella company

Operating under an umbrella company eliminates the burden of the additional paperwork. All you have to do is submit time-sheets to the umbrella company, which will invoice and chase the client on your behalf.

However, like a PAYE employee, all your tax and National Insurance payment contributions are deducted before you get paid, which reduces your take-home pay. Umbrella companies also charge a fee for their use.

Typically, contractors who set up their own limited companies can expect to take home around 75-80% of their pay, but they will have to do some additional work.

For contractors operating under an umbrella company, it’ll be more like 60-65%, but they do not have the additional administrative burden.

How do you form a limited company?

If you choose to operate through a limited company, the process of setting up the company is actually quite simple. Registering a limited company can be completed through the Companies House website. To register your company, you will need:

  • A company name
  • A company address
  • At least one director
  • At least one shareholder
  • The agreement of all initial shareholders to create the company
  • Details about the company’s shares
  • Written rules about how the company will be run
  • Details of individuals with significant control over your company – i.e. anyone with over 25% of the shares
  • Your standard industry classification (SIC code) which identifies what your company does

Once you have provided all this information and paid a small fee, you will then receive your Certificate of Incorporation. This confirms the company legally exists. You will then need to register for Corporation Tax within three months of starting to work.

If at any time the company’s turnover exceeds £83,000 for any 12-month period, you will also need to register for VAT.

It’s also worth nothing that you should set up your limited company as soon as you can before commencing your first contract as this will eliminate any delays.

What are your responsibilities as a limited company contractor?

If you decide to operate as contractor through your own limited company, there are a number of legal obligations you will need to be aware of. This includes:

Annual accounts

Accounts will have to be submitted to Companies House – typically nine months after your year-end date.

CT600 (corporation tax return form)

This will need to be submitted to HMRC alongside a set of year-end accounts.

Submitting VAT returns and making payments (if applicable)

If your annual income is over the £83,000 threshold (2016/17), you have to submit your VAT returns to HMRC and pay your liability via direct debit or BACS.

Paying PAYE and NICs

PAYE and National Insurance Contributions should be paid by bank transfer. If payroll is run on a monthly basis, HMRC must be notified via real-time information (RTI) of the payments that need to be made.

Confirmation Statement (formerly the Annual Return)

A Confirmation Statement (this is the document that replaced the Annual Return in June 2016) will need to be delivered annually to Companies House and should include information about any changes that have been made to the company’s shareholders, directors or registered offices.

Submitting RTI

Real time information must be sent to HMRC every time you run the payroll. This process can be automated with the use of dedicated payroll software.

Submit a self-assessment tax return and pay any liability due

Directors of limited companies must also complete and submit a self assessment tax return and pay any tax liability due.

About the author

This article has been provided exclusively to ByteStart by KPMG Small Business Accounting, specialist accountants for contractors and small businesses.

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