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Umbrella companies vs. limited companies for contractors

October 11, 2011

One of the first things a new contractor has to decide is whether to contract via a limited company or an umbrella company. What are the advantages and disadvantages of each option?

Although ‘freelancers’ can trade in many different ways, for contractors the choice is much smaller. Contractors work on fixed term contracts with end clients, and due to industry and employment status conventions, the contract is almost always signed between the client and another company. This company being the contractor’s own limited company, or an umbrella company.

Tax

A limited company is the most tax efficient structure to trade under. A contractor will take a small salary (usually below the NIC threshold), and take most of his income in the form of dividends.

An umbrella company contractor will receive his income in the form of a salary, which is subject to normal national insurance and income tax rules.

IR35

If a contractor is caught by the IR35 rules, the advantages of trading under a limited company are much reduced, although there are still some benefits such as joining the Flat Rate VAT scheme and being able to claim for some expenses unavailable to umbrella company employees.

Many contractors may think that these benefits do not outweigh the ‘hassle free’ lifestyle which comes with being an umbrella company client.

Administration

As a limited company contractor, you are responsible for the administration of your company, dealing with Companies House, and the company accounts. A specialist contractor accountancy firm can help take most of the burden away from you, leaving you with an hour or so per month of accounts administration.

Umbrella company contractors, on the other hand, have virtually no paperwork to concern themselves with, which is one of the main attractions of this business structure

Other Considerations

Umbrella companies offer a good solution for people who may just want to test the water in the contracting world, or just have a one-off, or very short term contract opportunity.

When choosing an umbrella company scheme, be cautious about any claims that you can “earn money from expenses”. By law, you can only reclaim expenses which have been incurred solely during the course of your contract duties.

As a limited company contractor, you will have more control over your own affairs – both administrative, and financial, than an umbrella company contractor. This might be a good option if you need to present a more ‘professional’ image in any other business affairs you may have.

Further resources

For more on the subject, read;