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Limited or umbrella companies – which structure is best for contractors?

October 11, 2011

The vast majority of contractors and freelancers work through their own limited companies, or use the services of umbrella companies. Which is best for you depends on a number of factors.

The limited company option

In essence, the most tax efficient tax structure to use is a limited company. By drawing a low salary and taking the majority of your income in the form of dividends, you will minimise your exposure to income tax and national insurance contributions.

Limited company contractors have control over their finances, but they do have a number of financial and statutory obligations to comply with. Most of these administrative duties can easily be taken care of by a specialist accountant, however the responsibility for ensuring the correct forms and accounts are submitted to the authorities correctly, and on time, rests with the contractor.

If your contract or freelance work is caught by the IR35 rules, the tax benefits of working via a limited company are drastically reduced as you will be forced to extract funds in the form of a “deemed salary” rather than the salary+dividends mix.

There are still some benefits to operating via a limited company if you are caught by IR35 (such as the benefits of the flat rate VAT scheme and usage of the 5% expense allowance), but for many it is simpler just to operate via an umbrella company, which requires very little administration on the part of the contractor.

The umbrella company option

For contractors who are on short-term contracts, or those who don’t want any of the perceived “hassle” associated with running a limited company, an umbrella company is an attractive option.

Umbrella company contractors can get up and running with a scheme almost immediately. The umbrella company takes care of all your paperwork, and will pay you on an agreed payment cycle, your salary and expenses, minus deductions for PAYE (income tax), national insurance contributions, and the scheme fee.

So, in essence, if you are not caught by IR35, and are set on contracting for a reasonable period of time, setting up a limited company would typically be the most sensible option to take.

If you are contracting for a short time, don’t want any ‘hassle’, just want to test the water, or if you are caught by IR35, an umbrella company may well be the best option for you. There’s more in this guide from ITContracting.com