When choosing the best business structure in the UK, contractors and freelancers often compare setting up a limited company with working through an umbrella company. Each option has its own advantages and disadvantages, suited to different professional needs and situations. This article explains these differences to help you decide.
Before we make the comparison, let us first understand both limited companies and umbrella companies.
What is a Limited Company
A limited company in the UK is a business structure that has its own legal identity separate from its owners (shareholders), offering them limited liability protection.
In the UK, a limited company must be registered with the Companies House. Upon registration, the Companies House issues a unique company registration number to the limited company.
The name of a limited company must always end with ‘Limited’ or ‘Ltd.’ As mentioned above, this gives the company its own legal identity.
What can a Limited Company Do?
Because a limited company has its own ‘legal identity,’ making it a separate entity from its owners under the law, it:
- Can enter into contracts in its own name, including hiring staff
- Is accountable for its own actions and can initiate or face legal action
- Has the legal right to the money it earns from sales and can retain its profits
- Is responsible for settling its own debts and liabilities.
Benefits of working through a Limited Company
- Ownership and Control: As the director of a limited company, you have full control over the business operations, financial management, and strategic decisions. Additionally, you own the company’s profits, which are subject to corporation tax.
- Limited Liability: Your personal assets are protected. If the company faces financial trouble, you’re only responsible for what you invested.
- Tax Efficiency: Limited companies often pay less tax than individuals, and you can take advantage of various tax reliefs.
- Professional Image: Having “Ltd” after your business name can make your company look more professional and trustworthy.
- Separate Legal Identity: The company is its own legal entity, meaning it can enter into contracts, own property, and be sued, separate from you personally.
- Ownership and Control: As a director, you have control over the company’s decisions, and you can retain profits after paying taxes.
- Flexibility in Income: You can choose to pay yourself through a combination of salary and dividends, which can be more tax-efficient.
- Business Continuity: The company can continue operating even if ownership changes, making it easier to sell or pass on.
What is an Umbrella Company?
An umbrella company employs agency contractors who work on temporary assignments, usually through a recruitment agency.
Unlike a limited company, where a contractor has to take care of their own financial affairs, the umbrella company takes care of all the administrative tasks on behalf of the contractors. Tasks such as payroll, tax deductions, and compliance with employment laws are taken care by the umbrella company.
Contractors simply need to submit their timesheets to the umbrella company, which then invoices the client or recruitment agency and pays the contractor after deducting taxes and other contributions.
This type of arrangement allows contractors to enjoy employee benefits like statutory sick pay and holiday pay, while still retaining some flexibility typical of contract work.
Benefits of working through an umbrella company in the UK
There are several benefits of working through an umbrella company:
- Simple Administration: You don’t need to set up your own limited company. The umbrella company handles all the paperwork, including invoicing clients and payroll.
- Employee Benefits: You get employee perks like statutory sick pay, holiday pay, and sometimes even a pension, which you wouldn’t have as a self-employed contractor.
- Tax Management: The umbrella company deducts taxes and National Insurance before paying you, so you don’t have to worry about managing these yourself.
- Flexibility: You can work on different contracts through various agencies without needing to switch companies or manage multiple accounts.
- Compliance: The umbrella company ensures you stay within legal and tax rules, reducing the risk of mistakes or penalties.
- Focus on Work: Since the umbrella company handles the administrative tasks, you can focus more on your job and less on paperwork.
10 Things to Consider: Limited vs. Umbrella Company
When deciding between a Limited Company and an Umbrella Company in the UK, consider the following factors:
- Level of Control:
– Limited Company: You have full control over the business, including finances, operations, and strategic decisions.
– Umbrella Company: The umbrella company handles administrative tasks, leaving you with less control but more convenience. - Tax Efficiency:
– Limited Company: You can take advantage of tax benefits, such as paying yourself through a mix of salary and dividends, which can be more tax-efficient.
– Umbrella Company: Taxes are deducted at source, so you have less flexibility but fewer tax-related responsibilities. - Administrative Responsibility:
– Limited Company: You are responsible for managing all administrative tasks, including accounting, invoicing, and compliance with legal obligations.
– Umbrella Company: The umbrella company manages all administration, including payroll, tax filings, and invoicing. - Costs:
– Limited Company: There are costs associated with setting up and running a limited company, including accounting fees, insurance, and possibly hiring professionals to help with compliance.
– Umbrella Company: There is usually a fee for using the umbrella company’s services, which is often deducted from your earnings. - Employee Benefits:
– Limited Company: You don’t have access to employee benefits like statutory sick pay or holiday pay, but you can create your own pension and insurance plans.
– Umbrella Company: You get employee benefits such as statutory sick pay, holiday pay, and sometimes even a pension. - Flexibility:
– Limited Company: More suitable if you have long-term contracts, multiple clients, or want to grow your business.
– Umbrella Company: Ideal if you work short-term contracts, prefer less paperwork, or are unsure about your long-term plans. - Financial Risk:
– Limited Company: You have limited liability, meaning your personal assets are protected if the business encounters financial difficulties.
– Umbrella Company: The financial risk is minimal since the umbrella company takes care of liabilities related to tax and compliance. - Income Level:
– Limited Company: More advantageous if you earn a higher income, as you can optimize your earnings through dividends and other tax-efficient strategies.
– Umbrella Company: Suitable for those with lower or irregular income, as it provides a straightforward, hassle-free way to get paid. - Long-term Goals:
– Limited Company: Better if you plan to establish and grow a business, hire employees, or sell the company in the future.
– Umbrella Company: More practical for short-term contracts or if you plan to switch back to permanent employment. - IR35 Legislation:
– Limited Company: If your contract falls within IR35, operating as a limited company might be less tax-efficient, and you would need to handle compliance yourself.
– Umbrella Company: IR35 is less of a concern, as the umbrella company takes care of compliance, ensuring you stay within the rules.
Deciding between a limited company and an umbrella company depends on your personal situation, contract details, and what you prefer. Each option has its advantages and disadvantages.
If tax savings and having control over your business are important to you, a limited company might be the better option. On the other hand, if you want a simpler setup with employee benefits, an umbrella company could be a better fit. By understanding the differences and considering your work situation, you can choose the option that best matches your goals and lifestyle.
