Limited Company or Umbrella?

Limited Companies and Umbrella Companies represent the two most common ways to operate as a contractor or freelancer. Both are used across a variety of industries, spanning everything from technology to financial services to healthcare. Knowing the differences between the two is critical to determine the best course of action, given that both have their advantages and disadvantages. Below is important information you need to know if you are considering either a Limited Company or Umbrella Company.

Limited Company

Limited companies are legal entities self-employed individuals establish for the purposes of conducting business. A limited company is separate from a contractor’s personal assets; business assets are owned by the company rather than the individual. Finances are also kept entirely separate. As the owner of a limited company, you are also the company director. You are paid a salary by the company as determined by you.

Limited Company Advantages

The biggest advantage of setting up a limited company is financial. In a broad sense, owners of limited companies have greater earning power compared to umbrella contractors because their position is more tax efficient. Contractors with limited companies can take home as much as 80% of their earnings as compared to 65% for umbrella contractors. Setting up a limited company also offers benefits in terms of VAT and claiming expenses.

Other advantages of limited companies include:

  • Expense Management – Limited companies have a broader range of expense options that can be claimed for tax purposes. Virtually all business expenses that are incurred wholly and exclusively in the normal business operations can be claimed. Keep in mind there are differences between IR35 and in non-IR35 companies insofar as expenses are concerned.
  • Legal Status – As an established legal entity, the limited company is its own enterprise. This accomplishes two things. First, it reduces the financial risk of the contractor by keeping assets and finances separate. Second, it adds an extra layer of professionalism that helps the contractor build his/her business more quickly and with a better reputation.
  • Business Control – Unlike the umbrella contractor, a limited company contractor has total control over every aspect of his/her business. He/she negotiates contracts, raises invoices, handles collections, determines when and where to work, etc. If total freedom is what you are after, a limited company is the better option.

Limited Company Disadvantages

Limited company owners routinely say that their administrative responsibilities qualify as the biggest disadvantage of their chosen business model. There is quite a bit of administration involved, including record keeping. Limited companies must keep detailed accounting records of income and outflow, outstanding company debts, assets and liabilities, and all goods purchased and sold. Additional disadvantages of the limited company are:

  • Company Scrutiny – Limited companies are required to submit annual paperwork to Companies House. The details of those records become public as soon as they are received, making them available to anyone who wants to see them. This includes information regarding company accounts, officers, and shareholders.
  • Accountancy Requirements – Owners of a limited company must decide whether to handle all of their accountancy in-house or contract with an accountancy service. Either way, money will be spent on business accounting. It is a normal part of doing business.

Umbrella Company

An umbrella company is part recruiting agency and part standard employer, recruiting contractors and freelancers to fulfil assignments as per client requests. Contractors and freelancers are legal employees, submitting time sheets and expense reports in exchange for invoicing and payment processing. The umbrella company takes care of everything else. They handle invoicing, collections, PAYE administration, tax reporting, etc. They deduct a set amount from each contractors’ pay cheque, along with taxes and National Insurance contributions, in order to cover their costs and profit.

Umbrella Company Advantages

The primary benefit of working through an umbrella company is that of not having to worry about the financial administration aspects of business. The contractor can invest all of this time and resources in providing the services he/she is contracted for. Working through an umbrella company gives the contractor the freedom and flexibility of self-employment without the headaches of business administration. Other benefits include the following:

  • Temporary Work – An individual who turns to contracting as a temporary means of making a living between salaried jobs will find the umbrella company to his/her advantage. Because the umbrella company acts as an employer, the contractor can get in and out at any time. There is no commitment with an umbrella as there is with a limited company.
  • Personal Financial Management – Working through a reputable umbrella company usually means a steady stream of work and a reliable income. Moreover, because the umbrella company handles all deductions, the worker knows what he/she receives in his/her pay is subject to no further deduction or taxation. This makes for easier personal financial management.

Umbrella Company Disadvantages

There are a number of disadvantages to working through an umbrella company as opposed to establishing your own limited company. The primary disadvantage is decidedly financial. Simply put, working through an umbrella is the most expensive means of contract employment. Not only do you still have to pay taxes and make National Insurance contributions, you also pay the umbrella company to provide you with business administration services. Umbrella company contractors can earn as much as 30% less than limited company owners.

Other disadvantages to the umbrella company include:

  • Legal Status – A contractor working through an umbrella company is legally classified as an employee of that company. As such, it can be difficult for the contractor to develop solid relationships with clients looking to work with actual business owners. The contractor may be seen more as a temporary worker than a person that can be trusted as a long-term asset.
  • Business Control – The amount of freedom and flexibility afforded umbrella company contractors is somewhat restricted as compared to their limited company counterparts. As a legal employee, your freedom and flexibility are confined to the assignments you accept and how you fulfil those assignments. The umbrella company is in control of everything else.

I-CAS offers affordable and reliable accountancy services to contractors, freelancers, and limited company owners. For more information about our services, or if you are interested in setting up a limited company of your own, contact us right away.