When deciding between contracting via an umbrella or limited company, the main factors to consider are typically; the tax differences between the two structures, your IR35 status, and how much perceived ‘paperwork’ is involved. One service provider says that 50% of umbrella company contractors would be better off by incorporating.
Umbrella vs. Limited – the Pros and Cons
The ‘limited vs. umbrella’ question is probably the most frequently asked by prospective contractors and freelancers.
Assuming that IR35 does not apply (as the tax benefits of working via a limited company are massively eroded), many would-be contractors may be put off incorporating due to the legal and financial obligations faced by limited company directors.
In reality, although the buck does ultimately stop with the directors, almost all company paperwork can be safely processed by a competent accountant. If you invest in a robust online accounting system, you only need to spend an hour or so each month to keep your company records updated – including invoicing, and dealing with enquiries from your accountant.
The main difference between the two structures comes down to tax:
Umbrella company contractors are employees, subject to standard payroll taxation. Limited company contractors, on the other hand, can draw down their income in the form of a small salary (below both the income tax and National Insurance thresholds) and dividends (which are free from NICs entirely). There are also a number of tax planning benefits, including the potential to split company shares with a spouse.
One suspects that another factor may be how knowledgeable new contractors are when they start out – an influential recruitment agent may suggest that an umbrella scheme is the best business structure to use, even if this is not the case. Some agencies have strong links to service providers, and may earn commissions for recommending umbrella services than accountancy providers.
‘50% of all umbrella company contractors should go limited’
An alternative finance provider for freelancers, UC Finance, says that up to 100,000 contractors could be missing out on 11% of their annual earnings by working via an umbrella company. This amounts to around half of estimated 200,000 umbrella scheme employees in the UK.
The company says that a contractor earning £250 per day could save £10,000 per year by switching from an umbrella company to a limited company.
We asked the company’s MD, Joanna Holloway, to explain more:
“Having considered the current legislation and drawn on the expertise of our partners during this study, we believe that contractors whose contracts fall outside the IR35 regulations could well benefit financially from switching to limited company status.”
“It’s clear from our study that non-IR35 contractors could be losing significant sums of money each year by failing to explore more affordable financial solutions available to them. By remaining with umbrella companies, one person limited companies may be doing themselves an injustice, paying over the odds for a service that’s ultimately built on contractors’ fears of falling foul of IR35, and payment insecurity.”