For independent contractors serving all sectors, finding the best and most fitting business structure is important. Your chosen business structure could provide a route to better profit margins, improved tax efficiency and greater opportunities. There are a number of business structures to explore, but the battle between limited company and umbrella company, two key structures called upon by contractors, is one that is heavily debated. Although there are pros and cons for each of these structures, comparing the two, and understanding how the advantages and disadvantages affect individual circumstances, is vital.
As a leading provider of payroll processing solutions for contractors and recruiters, we understand the differences between limited companies and umbrella schemes more than most. Read on to discover how these popular business structures compare for contractors.
Better tax efficiency for limited companies
Forming a limited company to run your contractor business is considered the most tax efficient way to contract. Through a limited company you not only benefit from limited liability but have the option to pay less personal tax than sole traders or those working via an umbrella company.
By setting up a limited company you name yourself as the director or shareholder, and can choose to draw a small salary, taking the rest of your income in the form of more tax efficient dividends. By drawing a small salary along with dividends you can minimise the amount of tax and National Insurance (NI) you pay. This guide from Bytestart provides an excellent insight into the taxation of dividends as a limited company director.
Less administration for umbrella contractors
As a contractor it’s unlikely that you’re also an accounting specialist, a fact that makes fulfilling your own tax and NI obligations particularly daunting. By joining an umbrella company scheme you don’t have to deal with the added administration that comes as standard when forming a limited company, as IT Contracting explains:
“If you join an umbrella company, you will become an ’employee’ of the scheme. The client pays the scheme when you have submitted a weekly or monthly invoice, and you will receive a salary after deductions for tax, National Insurance, expenses, the umbrella fee, and any other pre-agreed costs. It is not as tax efficient a business structure to use as the limited company route, however it does represent a ‘hassle free’ way to contract, which may appeal to contractors who are testing the water, short-term contractors, and those who do not want to take on any form of administration.”
Freedom to grow with limited
With a limited company, you have complete control over how your business is managed, portrayed and expanded. As the director of your own company rather than an employee of an umbrella company, you have the final word on which contracts your company takes on, how you invoice your clients or the agents representing them, and how associated expenses are managed. As the company director you can even choose to take on employees to grow your business.
Both becoming an employee for an umbrella company and forming your own limited company have their positives and negatives. As a limited company you have all the control but are in charge of paying your own tax, NI and insurance. Umbrella employees may have limited control but benefit from reduced administration, and can profit from lower paid and short term contracts.
Weighing up which is more beneficial for you is essential. We have experience working with all types of contractors, contact us today for advice on which is the best business structure for you.