Limited Company vs Umbrella

Limited Company vs Umbrella

If you are a freelancer or agency worker, regularly working on short-term contracts, often you will not be able to engage directly with the end client (as a sole trader) and so will be required to work through a separate entity such as a Limited Company or an Umbrella Company. Below we discuss the pros and cons of trading through a limited company opposed to engaging an umbrella.

Pros

Opportunity for Tax Planning

One of the main reasons that contractors decide to trade as a limited company is that it provides greater opportunities for them to arrange their affairs in order to minimise their tax liabilities and increase take home pay. Contractors trading as a limited company can typically take home 75-80% of their contract amount, opposed to 60-65% by those that use the services of an umbrella company. Below are some of the ways that taxes are minimised with a limited company:

Flat Rate Scheme for VAT

By registering your company for the Flat Rate Scheme, VAT will be charged out at 20% on invoices but paid over to HMRC at a lesser percentage (based on the nature of trade undertaken by the company). The difference is additional income to the company. Note that the Flat Rate Scheme is usually only beneficial to use in the first year of VAT registration if the company is classed as a limited cost trader.

Salary/Dividend extraction

As a director of your own limited company, you have freedom to choose the level of salary that is paid to you by the company (provided IR35 does not apply). The most common, and tax efficient, salary to set is one at the National Insurance threshold (£8,464 for 2018/19) – at this level there will be no Income Tax or National Insurance due; any remaining profit in the company can then be taken as dividends which have favourable rates of tax compared to a salary.

Share Structure

Another common tax planning method is to allocate shares in the Limited Company to a spouse (if they are a basic rate taxpayer) – in doing so it means that more dividends can be taken from the company utilising the dividend allowance (£2,000 in 2018/19) and the basic rate of tax.

Expense Claims

Tax relief can be claimed on any expenses that have been wholly and exclusively for the purpose of trade. The variety of expenses that can be claimed from a limited company will typically be wider than what can be claimed from an umbrella.

Exit Planning

When you have ceased to trade as a contractor and the Limited Company is no longer needed, the company can be closed down and (subject to you meeting the qualifying criteria) any remaining funds will be treated as a capital gain and entrepreneurs relief applied – this will then be taxed at just 10%.

Control

When trading as a company, you retain a greater degree of control over your finances rather than this being passed over to a third party that will have their own business risks. It is your company that will collect your fee income and pay it to your personal account, and the company bank account is maintained by you. In the past there have been umbrella companies that have ceased trading and not paid their contractors, leaving money owed to many people.

Cons

Administration

As a director of a limited company, you will have several administrative responsibilities such as filing annual accounts and returns with Companies House, filing tax returns with HMRC and also for making tax payments (both for yourself and on behalf of the company) to HMRC. People that engage an umbrella company do not have these obligations and all the tax that they need to pay will be deducted at source.

Privacy

Personal information about the directors and shareholders of a company are published at Companies House for use by the general public.

Conclusion

For short-term contracts or low value contracts, it is usually better to use an umbrella due to the reduced administration involved. For longer term, higher paid contracts, it would be beneficial to trade as a Limited Company due to the tax saving and the higher degree of control contractors have over their finances.


For more information on the differences between limited companies and umbrella, get in touch with a member of the Alchemy team today on 01772 965550, or email: hello@alchemyaccountancy.com.

Craig McCall
hello@alchemyaccountancy.com