Getting it right

How to setup your contractor company?

Traditionally, IT contractors have found it necessary to setup limited companies to work. Considering the tax advantages of using limited company, there wasn’t much of a reason for contractors to think about alternatives. Even with PAYE and umbrella companies now offering a viable option, majority of contractors still prefer going the limited company way and taking all the control in their own hands.

With introduction of IR35, majority of these tax advantages were gone now. However, for contractors falling outside this intermediary legislation, a limited company is the best option even today. An umbrella company will be a better option for IT contractors caught by IR35.

Setting up a limited company

Majority of IT contractors prefer setting up a limited company.

To setup your own limited company, you can complete the whole process online. It will just take a few hours and there won’t be any hassle if you have chosen a decent company formation service.

Joining an Umbrella Company

Contractors caught by IR35 will prefer umbrella companies over limited companies because of less administrative hassle involved.

Umbrella companies process invoices for contractors and receives payments from clients on behalf of these contractors. It then computes tax and NI contributions, deducts them along with company’s service fee, and sends the remaining amount to contractor’s bank account.

In the past umbrella companies proved to be a costly option considering all the tax advantages that come with limited companies. However, introduction of IR35 made is a viable option as this legislation removed majority of tax benefits associated with limited companies.

Setting up PAYE with your agency

Some agencies operate their own PAYE for their contractors.

With this option, you will be paying maximum tax and NI contributions on every cent that you earn through this settlement. On top of that, you can’t claim even valid business expenses. This is the reason that majority of contractors avoid this option.

What’s right for you? Limited or Umbrella?

If you are about to leave permanent employment to step into contracting then your first task is to decide about your business structure. In this particular step, you have to design your business in a way that allows you to make maximum income while paying minimum tax. You have to design your business structure in a way that allows your clients to communicate with you easily.

In this article, we will explore two main business models used by contractors including the Umbrella Company and Limited company.

Umbrella Company

The number of umbrella companies operating in the United Kingdom has grown rapidly in last decade. A large number of web based umbrella companies has emerged after the implementation of IR35 tax rules.

If you register yourself in an umbrella company, you will become an employee of the umbrella service provider. The client will send money to your umbrella scheme where they will deduct tax, NI contributions, service charges and the remaining amount will be sent to you. In this whole procedure, you job is only to submit timesheets and expense receipts on weekly or monthly basis.

Advantages of an Umbrella Company

When it comes to pros of an umbrella company, there are a lot of positive things that engage contractors to join an umbrella company. Let’s take a quick look at the benefits of an Umbrella Company.

  1. It gives an alternative route to those contractors who are not in the position to set up their own limited company for one reason or another.
  2. An umbrella scheme is a viable option if your contracts will come under IR35 tax rules.
  3. The admin work will be done by professional staff of the company, so you are completely free for your contract.

Disadvantages of Umbrella Company

  1. The biggest disadvantage of operating via an umbrella company is the delay of payments.
  2. The contractors come outside IR35 tax rules pay more tax burden as compare to operating via limited company.
  3. Umbrella Companies offer very limited amount of control over financial matters and you will be totally dependent on your service provider.

Limited Company

A limited company is an institution that can set up to run your business. It needs to be registered in Companies House and should be operated within Companies act 2006. There are two different types of limited companies including private limited company and public limited company.

A private limited company is usually a small business whose shares are not traded in the stock market. Whereas, a public limited company is a well known, large business who shares are traded on the stock exchange.

A limited company can be started with 40 pounds only by sending papers to Companies House and 13 pounds if registered online. After setting up the company, you will become director of the company and fully responsible for financial matters. You will have to meet with HMRC tax deadlines and submit annual accounts to Companies House.

Now, you might want to get a list of pros and cons of a limited company to make a decision. Here are the pros and cons of an umbrella company.

Advantages of limited company

  1. Setting up your own limited company provides you maximum freedom and control over your financial matters.
  2. If you are not caught by IR35 tax, you can enjoy maximum tax benefits by setting your own limited company.
  3. It allows you to introduce new investors and shareholders in the company.

Disadvantages of limited company

  1. Setting up a limited company will be costly if you are contracting for a short period of time.
  2. If you are contracts are caught by IR35 rule, you can’t take any benefit through setting up your limited company.

Conclusion

The type of your work matters a lot while deciding about the best possible business structure. If you think that your contracts will be caught by IR35 tax rules, then there are no benefits of setting your own limited company as you still have to pay full tax and NI contributions. In this case, an umbrella scheme would definitely be a feasible option.

On the other hand, if you expect that your contracts will not be caught by the IR35 tax term then you should set up a limited company to enjoy maximum benefits.