April 21, 2018 0

Umbrella Company vs Limited Company Which one to choose?

Umbrella Company vs Limited Company Which one to choose?


The dilemma faced by contractors is the choice between an umbrella company vs limited company. Wherever choice needs to be exercised, different options have their own set of advantages and disadvantages. It is no different here, and the actual choice or decision should actually depend on multiple factors of a contract. Before you attempt to understand if one choice or the other offers the best possible option, it is best to get the complete lowdown on company structure of a limited company and an umbrella company. Here is all that you need to know to choose the most suitable service for your needs.

What Exactly is an Umbrella Company?

An umbrella company is typically a UK limited company, functioning under a third part supplier of contractors who dons the role of intermediary ‘employer’. An umbrella company would enter into a contract on behalf of the employees with a client. The client could be a recruitment agency or an end client. The role of an umbrella company includes providing PAYE services to employees on its ‘roster’ or contract, and maintenance of all records pertaining to work hours, productivity, payments, deductions etc. For instance, the umbrella company would maintain all the time sheets of the contractors or employees who report for work, in addition to the invoices that will be required.  A contractor who offers his services to an end client through the umbrella company is entitled to claim certain expenses incurred, but the entitlement is subject to the clauses of the contract.

Processes Involved when opting for the Umbrella Company Route

#1 The umbrella company enters into a contract with the client (either a recruitment agency or an end client)

#2  The contractor will enter into a separate agreement with the umbrella company.

#3 As per the terms of the two different contracts, a contractor’s timesheet will be processed by the client and the umbrella company

#4 The client pays the umbrella company, and the latter subsequently release payment to the contractor after statutory deductions and agreed fee as per contract.

This, in a nutshell explains how the system works. There will be the options of claiming for expenses, and other claims at the end of year at the time of filing income tax returns. 

How does a Limited Company fit in here?

The company structure of a limited company established by a contractor, can have him in the role of a director and as a principal employee. By doing so, the contractor will be in a better position to reduce his tax outflow while earning handsomely. It simply involves the drawing of lesser salary, while drawing a major chunk of earnings as dividends. This helps in reducing tax exposure, while eliminating the need for PAYE salary accounting and National contributions as an employee. However, the establishment of a limited company involves registration with the Companies House and the HMRC, in addition to filing the necessary returns on time and making the remittances necessary as per regulatory requirements. This can be offloaded to accountancy firms who will handle all the aspects – from company formation to filing of returns and remittances. The advantages of this option is that despite the expenses that will be necessary for the establishment of a company and the mandatory remittances, it will still work out to be better – financially. However, the terms of the contract need to be reviewed properly to ensure that it does end up getting caught in IR 35 net.

Main differences between Umbrella Company vs Limited Company UK

Some of the differences between both the types of companies are listed out here for viewing at a glance, which will help to make a quick choice.

Umbrella Company

Limited Company

Suitable for a very short stint as a contractor. Suitable for longer stints as contractor.
Does not stand the risk of getting caught in the IR 35 net The terms of the contract and the working practices at the clients place determine if the contract will get caught in IR 35.
Will be paid salary through PAYE Does not require PAYE system
Involves national contributions Does not involve national contributions
Does not require any registration with Companies House Requires registration with Companies House
Does not require filing of returns with HMRC Requires filing of returns with HMRC
Remuneration is through salary and claims for business related expenses, wherever permitted Remuneration is through small ratio of salary, with high ratio of dividends
Generally lesser control over monetary affairs Greater control over monetary affairs
Comparatively lesser earnings than self employed contractor Comparatively more earnings than employee of umbrella company

These are the typical differences between the two types of engagement. To be engaged with clients as a contractor in an own limited company, it is necessary to bear two important factors in mind. One, the need to check if the contract is outside the IR35. Two, timely compliance with regulatory requirements. Both of these requirements can be easily handled by accountants, who will help contractors to work out a profitable venture with minimum tax exposure as per legitimate provisions and reliefs.

Checklist to Determine Suitability of options

While the table above provided a comparison of the intrinsic difference between the two models of engagement, it is necessary to apply a few filters to ascertain which is the most suitable. Here are a few questions that can be self-addressed to determine which of the two models are more suitable and appropriate.

#1 – Will I be better off with greater control of the amount of money that I earn, in a legitimate manner? Am I more concerned about the amount of money that I may have to lose by way of tax?

If you desire to have greater control on your earnings, then certainly, you need to be looking at setting up your own limited company. Because with an umbrella organisation, you will be entirely at the control of the terms of the contract that you sign and that the umbrella company signs. If you are concerned about the amount that you will stand to lose as a result of tax deductions as a ‘employee’, then you need to choose a limited company to offer your services.

#2 – Am I planning to offer my services as a Contractor on a long term basis?

If you are planning to be in contracting for the long haul, then you definitely need to be in your own company. For instance, if you feel that your lifestyle, requirements and nature of work befits a long term contractor assignment or multiple assignments, you need to look at establishing a limited company. However, if you are looking at a very brief stint, or a stop gap arrangement, then you should be looking at an umbrella company. It is certainly not the best idea to set up a company and disband it in a few months time.

#3 – Is the nature of my service provided through contracts liable to fall within the IR 35 net?

If the service that you intend to provide or are providing, falls inside the IR 35 net, then it would be a good option to first get it reviewed by accounting firms, before you opt for a limited company establishment. Because, if a professional scrutiny and review of the contract or service that you will be providing, indicates that it will get caught by IR 35, then it is not worth going for a limited company. However, if the accountant is of the opinion that the terms of the contract and the working practices can be lawfully aligned to meet HMRC obligations, you can opt for the limited company option.

What to look out for?

Rather than choosing an option blindly, it would serve your interests better to be fully aware of the little catches in each system. For instance, if you opt for an umbrella company, you need to be aware of the payment cycles that they follow. The best umbrella companies will make payouts at pre-determined intervals, regardless of when they receive the payment from the end client. Some companies will release payments only after receipt of the same from the end companies. You need to be fully aware of the system that is being followed and ensure that the same is listed out clearly in the agreements.  When you sign up with the best umbrella companies, the agreements will more or less be in near perfect order, with only small changes required. On a similar note, you need to first ensure that your contract is not likely to fall inside of the IR 35 net, before you opt for a limited company. These little precautions will help to make the ride smoother, after you have made the choice.

Nature of Services to Meet Regulatory Requirements

If you choose to establish your own company, after having made a careful decision on the basis of a proper comparison and specialist accounting advice, you can outsource all compliance related work to accounting firms. Service providers with rich domain experience in most fields offer complete end to end solutions and accounting advice for individuals who wish to establish their own companies. This way, contractors can look forward to hassle free earnings, with less tax exposure, and greater control of revenue.

Find an Accountant to help you with Company Formation & related compliance’s

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