Limited Company or Umbrella Company

Our contractor service compared to umbrella companies

Our all-encompassing service for contractors is just as simple as using an umbrella company, but far more tax efficient.


What is an umbrella company?

If you use an umbrella company, you will become their employee and they will hire your services out to the end client. You will submit your time sheets and expenses and be paid a salary plus reimbursements. The umbrella company will deduct Income Tax from your pay at your highest rate of tax via PAYE in the same way as any other employer would do. They will also deduct Employees National Insurance Contributions in the same way. However, you will also have to pay the Employers National Insurance Contributions that an employer would normally pay on their staff's pay. The umbrella company is not going to pay this for you. In addition, you will also have to pay the umbrella company for using their services. What's left after all these deductions is your take home pay.

How does a limited company differ?

If you set up your own private limited company, you will be an employee/director and shareholder of your own company and your company will hire your services out to the end client in a similar way. However, your client will now pay your company directly instead. From this income you will be able to deduct all your expenses and running costs and decide how best to remunerate yourself as an employee to achieve the maximum take home pay.


Why most contractors are better off setting up their own limited company

1. More tax efficient

Using your own private limited company means you will usually be able to minimise the amount of overall tax you pay. The tax saving is achieved by taking your income via a strategic mix of salary and dividends instead of just a salary. You will only receive a salary plus reimbursed expenses from an umbrella company which means you will potentially pay more National Insurance Contributions and more income tax.

2. Just as simple if you choose the right accountant

People often choose to use an umbrella company instead of setting up their own company because they perceive it to be easier. That might have been the case in the past, but these days with the right kind of support from an accountancy firm who understands the needs of contractors and freelancers, providing your services through your own limited company is just as simple and hassle free. We can take care of all the admin and record keeping, leaving you free to do what you do best. Simply raise your invoice for your client, then submit your expenses claim into our online portal, and we'll take care of everything else in the same way as an umbrella company would do.

3. Beware of phony umbrella companies

There are numerous firms advertising themselves as umbrella companies on the internet. However, any firm that guarantees your net take home pay to be over 85% is probably not a traditional umbrella company. These firms rely on tax avoidance schemes, offshore structures or complex loan arrangements to minimise your tax and do not operate in the same way as a standard umbrella company. The tax avoidance methods these firms use are extremely high risk and you may find yourself suffering penalties and actually pay more tax that you needed to if HM Revenue & Customs determine that the company you have used has not acted within current tax legislation. You should be very wary of any firm that states that their service is more tax efficient than a limited company, or doesn't clearly explain enough about their services on their website and instead encourages you to telephone or request a call back.

4. Cost effective

The cost of operating a limited company is usually simialar to the fees charged by umbrella companies. It is therefore just as cost effective to set up your own limited company. We will even pay for the company formation for you and handle all your registration responsibilities with HMRC. Take a look at our fixed fee accountancy packages for contractors.

5. Benefit from VAT registration

You can register for VAT and reclaim VAT on your costs and expenses. Or you can use the Flat Rate VAT Scheme if you are eligible and if it will benefit you. This works by charging VAT on your invoice to your client, but then paying over a lower percentage to HMRC to compensate your company for not claiming VAT on its expenses. If you used a standard umbrella company you would miss out on this extra income.

6. Claim the Employers Allowance

Employers can save up to £4,000 in Employers National Insurance Contributions. This means that your company can save contributions on the salary it pays you as a director. If you use an umbrella company, you will have to pay the Employers National Insurance Contributions on your salary yourself and they will not be able to offer you any saving on this because the £4,000 allowance will have already been used up on their own contributions for their own staff.

7. Make your spouse a shareholder

Under current tax law you are able to make your spouse or civil partner a shareholder in your company and effectively split your income between you. This is especially useful where your spouse or partner is not working or is a basic rate taxpayer, but your income pushes you into higher rate tax. By splitting the shareholding in your company, you can make sure that more of your income is taxed at a lower rate. Umbrella companies do not offer this opportunity.

8. Employ your partner

In a similar way to item 7 above, you can employ your spouse, civil partner or common law partner in your company. If they have no other income or pay a lower rate of tax than you, then the two of you combined would pay less tax. Again, an umbrella company does not offer this opportunity.

9. Claim more expenses

The scope for claiming legitimate tax deductible expenses is much wider when you own a private limited company compared to using an umbrella company. Travel and subsistence expenses are also now restricted for those using an umbrella company in most instances.

10 Opportunity to grow

Finally, forming your own private company gives you the opportunity to expand your client base and actually grow beyond standard contracting. It adds an element of professionalism and transforms your contractor style company into a real business. We have many clients who started out with a single contract with one client and were maybe even a little nervous about their future after that expired, but in fact have gone on to actually grow their business far beyond their initial expectations.

Find out more

Take a look at our fixed fee accountancy packages for contractors, or contact us to learn more about our services.