One of the most important decisions that first-time business owners and contractors face is the choice between limited and umbrella companies. Whereas it is always recommended to seek professional advice from an accountant or a solicitor, there are some guidelines that can point business owners in the right direction. This article has been written with the objective of helping contractors and business owners make a wise decision and benefit from the best payment structure.
Limited Companies: Advantages
Larger Net Income
Generally speaking, setting up a limited company helps business owners retain a larger percentage of their income. Limited companies have access to preferential flat-rate VAT and other tax benefit schemes that result in a larger take-home income.
Being a limited company contractor creates a professional image and can help enhance the reputation of a business.
Limited Companies: Disadvantages
Initial costs can be relatively high, although it is possible to find accountants who will take care of the initial process for free, or in exchange for repeat business. This might be a good option when it comes to minimising expenses, since owners of limited companies will anyway require the monthly services of an accountant.
Bureaucracy and Red Tape
Even if contractors hire the services of an accountant, limited companies require that a large amount of paperwork is kept in order. Simply setting up a limited company requires that contractors produce articles of association, memorandums of association, and several other documents.
Benefits of Joining an Umbrella Company
Convenience and Flexibility
The main benefit associated with joining an umbrella company is its convenience. Contractors and business owners needn’t worry about filing monthly paperwork and other administrative tasks, as these are taken care of by the umbrella company. Not having to worry about taxes, national insurance payments, and other accountancy matters can certainly lighten the burden of running a business.
Since there are no long-term commitments associated with umbrella companies, this flexible arrangement is ideal for those who work on short-term contracts.
Since the implementation of the IR35 rules, the costs of joining an umbrella company are significantly lower when compared to those related to limited companies. There are two fee payment schemes: paying a fixed weekly or monthly fee, or paying a percentage over weekly income The first option seems to be the most popular, and average monthly fees range between £80 and £120. While the second option may seem more costly, there are umbrella schemes that apply a cap to the amount that can be raised. Percentage-based fees are more convenient for contractors who do not expect to raise invoices regularly.
Umbrella Companies: The Cons
Lack of Control Over Finances
When working through an umbrella company, any payments made to a contractor or business owner go first to the company, who only releases the final payment after all deductions have been made. Therefore, payments can take a while to finally reach a contractor’s bank account. It is also important to keep in mind that umbrella companies set their own rules as to when payments are released (whether it is weekly, fortnightly, or monthly).
Limited Tax Efficiency
Unless the majority of contracts fall under IR35 rules, joining an umbrella company might not be the most tax-efficient solution for a contractor. After deducting taxes, national insurance contributions, and the company’s fee, the resulting take-home salary might be significantly reduced.
It is crucial to give serious consideration to the issues mentioned in this article before taking a final decision. And in any case, it is worth remembering that it is easier to switch from umbrella company to limited company than doing the reverse.
David webster is a trainee accountant who has been interested since he was bought some shares as a kid. He now follows all things financial and trades forex for fun.