A limited company can offer significant tax savings over an umbrella company but only if you are outside of the rules called IR35.

Limited company tax

Contractors who work for their own limited company can make significant tax and NIC savings by paying themselves a salary of around £8,000 and then taking the majority of their earnings as dividends.  Dividends are not subject to National Insurance contributions (NIC) like salary making them a more tax efficient way of withdrawing money from your Limited company.

When you contract or freelance through a limited company, your contract revenues are paid to your company.  After paying for any expenses, company profits are liable to corporation tax of 20%.  Any profits after tax are called retained profits and may be paid out as dividends. Because Corporation tax has already been paid on these profits, the rate at which dividends are taxed to the person receiving them is reduced.  In fact, if the contractor only takes out salary and dividends up to the basic rate (20%) tax limit, then there is no further income tax to pay as the tax credit that comes with the dividend is deemed to have paid it.

Using a limited company to reduce the tax liability of contractors is particularly beneficial where the company is seen by HMRC to operate outside IR35, i.e. where the Inland Revenue does not consider you an employee for tax purposes. We’re not going into the whole “are you IR35 or not” here, but we would recommend speaking with experienced contractor accountants,if you need advice on this matter.

Differences between a limited company and an umbrella company

  • In a limited company the contractor, being the owner and a director, has full responsibility for the financial accounts, tax and VAT returns, company law obligations, etc. The contractor declares their own personal tax through self-assessment. This means more paperwork and time spent on accounts if the contractor does it own his or her own. However, limited company compliance can be greatly reduced by using a specialist contractor accountancy  firm such as PDS Accountancy.
  • With an umbrella company, the contractor is not an owner or company director and has no responsibility for running it. The contractor is an employee of the umbrella company and it is the umbrella company that invoices the client, receives the fees and then pays it to the contractor as a salary. This keeps your paperwork to a minimum. Tax on the salary is deducted at source (like a normal employee), however more tax will be paid overall, resulting in a lower take home wage.

Advantages of a limited company

  • It is cheap and quick to set up a limited company (free if you sign up with PDS)
  • The contractor has complete control over his money and company.
  • Money does not have to pass into a third party bank account, so faster transaction time and no risk to these earnings.
  • For those deemed outside of IR35, less tax and NIC’s to pay.
  • Limited companies offer greater opportunity to save tax because the contractor chooses how much money to take out (and therefore get taxed on) each tax year.  A limited company can be used like a piggy bank.
  • You can still work on contracts that are within IR35 from within a limited company with a small amount of help from your accountant.  You can work for your own umbrella company.

Disadvantages of a limited company

  • There is a lot of compliance to take care of e.g. invoicing, accounts and tax returns, etc, but remember this can be reduced by using the services of a specialist accountancy firm.
  • If your assignment is within the IR35,  rules you will not be able to obtain the tax advantages of setting up a limited company, but will have the additional overhead of taking care of the company accounts.
  • It might cost you a small amount of money and time to close the company down when you’re finished with it (PDS charges £120 to do that for you).

Advantages of an umbrella company

  • Avoids the time and trouble of having to look after the accounts and returns of the company.
  • Salary is paid to you as if you were an employee.
  • Not having to incur the costs of setting up a limited company, this is especially advantageous for those who know they are only in a short term contract.

Disadvantages of an umbrella company

  • The contractor has no control over the company or the company accounts or policies. The contractor is not a director.
  • It may take longer to receive payments as monies have to transfer through the umbrella company’s account before getting to the personal account of the contractor. How long that takes is down to the discretion of the umbrella company.
  • The contractor is leaving himself open to a certain amount of risk as his money will be paid to the bank account of a company he has no control over. Should that umbrella company get into difficulty or go bust, which has happened, he or she could lose his their wages.
  • Agency worker regulations (AWR) mean that those of you engaged in contracts of 12 weeks or more must be afforded the same rights as permanent members of staff, including paid holiday, sick, paternity/maternity pay. Your umbrella company administrator will simply withhold a proportion of your salary to cover these.
  • For contractors working outside IR35, choosing an umbrella company will leave them paying a lot more in tax, and even if inside IR35, choosing an umbrella will leave contractors slightly worse off financially.

Difference in take home pay

The difference in take home pay using a limited company is significant when compared to the umbrella company as the following tshows:

Daily                Take Home Pay
Rate         Umbrella        Limited Co

150                 95                108
200               153                120
250               141                188
300               162                219
350               183                250
400               204                281
500               243                342
600               279                397

Assumes travel and subsistence expenses of £4,000 pa, accountants fees of £1,270 and other of £570.

What to do Next?

Find out if your contract is outside of IR35 and understand how easy it is to switch to a limited company structure.  Call us, request  a call-back or email us at PDS Accountancy and talk to an expert.  It could save you thousands in tax.

Call us today on 01883 730044

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