Getting Started: Limited Company or Umbrella Company
Being a freelance contractor does not put you outside the taxation system. If you don’t get your structure right, you will make yourself vulnerable to an investigation by the Revenue (HMRC) which will almost certainly prove time-consuming, stressful and costly for you.
You can avoid falling foul of the Revenue by seeking specialist advice. Read this first though so you have an idea of what you want and how to go about it.
Trading Basics
Working out how to structure your company may seem like an uphill climb. Faced with numerous, mysteriously named structure options, the novice contractor may encounter some perplexing questions: Will an umbrella company protect me from a storm of paperwork? What will PAYE mean for my pay package? Will a limited company give me unlimited growth potential? But with a deep breath and a little research, the trading options for your business should become clear.
In fact, the question of trading structures for contractors is less complex than it may appear. The choices are as follows: to be a sole trader, to act as a partnership, to trade under an umbrella company, to operate as a limited company, or under PAYE of an agency.
Sole Trader
This is what most people refer to as ‘being self-employed’. The first step is to complete a SA303 form, which you can find on the HMRC website. At the end of each tax year, you then fill out a Tax Return with all income and expenses. You are entirely responsible for this, so keep careful records of all receipts. Your National Insurance contributions are also your responsibility.
A partnership can also operate in this way; all this means is that two people, rather than one, own the business.
Being a sole trader affords considerable tax advantages. On income above £29,400, you only pay 40% tax. There is also a relatively wide scope to offset expenses, further reducing the amount of tax you pay on income. National Insurance contributions for sole traders generally stand at a relatively minimal 7%.
However, there are also a number of significant disadvantages to being a sole trader. Be aware that, given these same tax advantages, sole trader status is not lightly awarded by the Revenue. For example, if you return to work for an old employer as a contractor, HMRC still sees you as the employer’s employee, and will tax you under PAYE accordingly.
Most importantly, your client’s organisation or agency can be held liable for your PAYE contributions if you, as a sole trader, do not pay the correct tax on your income. Consequently, many organisations will not transact with sole traders, only limited companies.
As a sole trader, you are personally liable for failing to pay tax, make NI contributions or complete on your contractual obligations. It is essential to be properly insured with professional indemnity cover and other appropriate policies (see Professional Indemnity Insurance).
Partnership
This is similar to being a sole trader, in that you trade personally, rather than behind the legal person of a company. However, one difference lies in the fact that partners are ‘jointly and severally liable’. This means that if, for example, your partner has an outstanding bad debt, then you can have an action brought against you too.
Umbrella Companies
Put simply, trading under an umbrella company brings a third party into the relationship between you and your client.
Many contractors go for this option, especially when first starting out. The beauty of the set up is that it enables contractors to avoid spending time on administrative tasks, which means they can focus more sharply on growing their business.
You become a salaried employee of the overarching umbrella (always on a PAYE basis), and your client contracts for your services through them. To an extent, an umbrella frees you of the responsibility of managing your own business affairs, taking care of your National Insurance contributions and paying income tax as you go. The only thing in your administrative ‘in-tray’ is to submit any expenses together with your timesheet. Adrian Learer of PlanIT Services, a specialist accountancy firm working with contractors, advises that there are a range of business expenses on which tax relief can be claimed through the umbrella company.
However, staying dry under the umbrella does not come for free - you need to pay the umbrella company either a weekly flat rate or a percentage of your income. You also need to make sure you are happy with the timeframe that the umbrella company will apply as part of the process of collecting payment from your client, and making payment to you.
Rates charged by umbrella companies vary, and so do the services they offer contractors. It may be worth talking to qualified specialist providers such as PlanIT who understand the tax and accounting aspects involved.
Limited Companies
Trading as a limited company puts you at the helm. Unlike operating under an umbrella company, the maximisation of profits and income you draw is entirely under your own control with no intervention by third parties. Neither do you have the same extent of personal financial liability that a sole trader does. In a limited company, shareholder liability is limited to subscribed capital. Your personal assets are usually exempt from consideration for, say, settling a debt.
If IR35 does not apply to your contract and you operate under a limited company, you have the right to claim dividends. Tax arrangements are thus possible which reduce a contractor’s salary but allow him to receive dividends, thus reducing the overall amount of tax and national insurance paid. Other such strategies involve paying a salary to a spouse or partner. However, the law in this area is complex, and tax planning with the help of a professional is always the best option.
A limited company also gives you the right to take on unlimited projects outside your job spec.
Claiming expenses is relatively straightforward within limited companies – for more information, see Tax, Finance and Money.
Much like being a sole trader, running a limited company means taking on considerable responsibility for its administration. This can include filing VAT returns, annual returns, banking and preparing detailed accounts. This inevitably creates its weight in paperwork; book keeping, profit margins and tax administration are the daily grind of the limited company director. Keeping careful records is essential, as is the utmost compliance with constantly shifting tax laws.
Setting up a limited company
Starting out as a limited company is more simple than you might think. Using the Internet, you can check a company’s name is available, appoint directors and shareholders and have it registered in a matter of hours. [See Companies Made Simple for more details]. Rules for set up include that the Director and Secretary may not be the same person where there is one Director, the presence of a minimum of one shareholder and one share to be issued.
Alternatively, there are specialist providers who set up companies and provide a full range of accounting and tax services.
Adrian Learer of PlanIT Services says that with the introduction of the MSC legislation contractors are always best-advised to consult qualified Chartered Accountants.
Agency PAYE
Lastly, if you undertake contracts via an agency, there may be the option of working under their PAYE system. However, this is unlikely to be the most tax-efficient method; under this arrangement, you pay full NI and tax on all your earnings. There are also implications for IR35; i.e you are more likely to be considered an employee under an agency contract.
|