Almost all contractors work through one of two arrangements, their own limited company (also known as a personal service company or PSC) or an umbrella company. The limited company route involves creating a company owned by you which engages with agencies or clients on a business-to-business basis, selling your services. Using an umbrella company involves becoming an employee of the umbrella company, which will invoice the agency/client, deduct tax, National Insurance and a fee and then pay you. Which you choose will depend on the nature of your role and what best suits your plans.
When choosing which approach to take you will need to consider:
- Is the contract in the public or private sector? The Off-Payroll Working in the Public Sector rules, which came into force in April 2017, make it less worthwhile to use a limited company for public sector roles. In addition to this many public sector clients now insist that contractors use an umbrella company.
- Are you experienced in contracting or a first-timer? Starting out in contracting can be a busy and confusing time, with a lot of changes all at once. Many people find it better to take the lower-administration route of using an umbrella company until they are used to contracting and sure that they are going to remain a contractor. It is usually possible to change your setup mid-contract, so you can always move to a limited company setup when you are ready.
- Is contracting a long-term career move or a one off between permanent roles? There are some administrative and legal duties involved in being a limited company director. If you only plan to work one fairly short contract before returning to being a permanent employee, retiring, or emigrating, then there is little point in going through the paperwork. For a longer contracting career, where you expect to work for multiple clients and for many years then having your own company will help you to build a brand and reputation, handle multiple clients, and achieve the best tax efficiency.
- How much administration are you willing to do in addition to your contracting work? As an employee of an umbrella company your administration is limited to getting your timesheet signed off by the client and sending it to the umbrella, however you will pay a fee for them taking on the administration. A limited company director will need to invoice the agency/client, chase payment, and handle the tax and regulatory requirements. The tax efficiency of a Limited company means that it is usually cost effective to hire an accountant to handle a lot of this work.
- How much will you be earning? For lower paid roles an umbrella company is almost always the best solution. The advantages of a limited company setup become a lot more marked for higher rate taxpayers.
- What level of expenses do you expect to incur while working on the contract? Limited company directors are able to claim, tax free, certain expenses that they incur wholly and exclusively in the course of their business. These can include travel to the client’s site, accommodation where the role is far from home, equipment for the company and other necessary spending. Umbrella company clients, as employees are not entitled to claim most expenses.
- Are you legally allowed to be the director of a company? The requirements to be a company director are not overly stringent, however if you currently have an undischarged bankruptcy or IVA, or have been struck off as a company director then you may not run a limited company and should use an umbrella company instead.
The advantages and disadvantages of each setup are explained in our guides, Contracting Through a Limited Company and Contracting Through an Umbrella Company.
