Limited Company vs. PAYE Umbrella: What’s the Difference?

By September 12, 2019 Insights
Limited v Umbrella PAYE

The first business decision you often have to make is to decide what business structure to operate under. As a contractor, you’ll have plenty of options with the most popular choice being between setting up a Limited Company or operating as an Umbrella Company. So what’s the difference?

Who’s the boss?

The big difference between the two is the control you have over your financial affairs. The answer to who gets to make the decisions and who is responsible for things like compliance depends on the business structure.

Limited Company – You’re the boss

When you set up a Limited Company, you’re in full control over the transactions and decisions you make as a contractor. The responsibility to comply with specific legislation, conduct tax payments and payroll calculations along with any other paperwork is on your shoulders.

The full control over your affairs doesn’t mean you wouldn’t use outside help at all. Limited companies often use tax advisors and accountants to help with the different aspects of running a business. However, you’ll still have full control over the decisions you make and responsibility to ensure your financial affairs follow the law.

PAYE Umbrella – You’re closer to being an employee

On the other hand, when you’re setting up as an Umbrella Company, you’re not going to be the main director. Since an umbrella company works under another company, you will not be responsible for everything. Your financial affairs and tax duties are on the shoulders of the hiring company. Naturally, this also gives them more power in terms of controlling financial affairs.

With an Umbrella Company, you are closer to the position of an employee. You’ll let the company know the hours or projects you’ve worked on, leaving them to pay you accordingly and dealing with things like NI contributions.

Limited Company Gives You Control, Umbrella Company More Time

Both systems do have their perks and you have to consider the advantages carefully before choosing the right structure for you.

The main benefits for a Limited Company boil down to control. As you’ll be in charge of everything, you get to decide just how you want to run the company. You’ll also have a better chance of effective tax planning because you can deduct more expenses as a Limited Company and you could choose your accountant.

However, you might also appreciate the advantage of fewer responsibilities when you work as an Umbrella Company. Since you don’t have to worry about filing your taxes or managing the payroll, you can focus more on delivering your work. The ease and simplicity of umbrella companies can appeal to many.

What about the bottom line?

In business, control and time-management aren’t the only important things. You’ll also want to ensure your livelihood – so how does setting up a Limited Company vs. Umbrella Company influence that?

In general, limited companies are the most tax-efficient model for contractors. Having your own company will help you save on tax and NI contributions, although much of it can depend on the level of income your company generates and the way you choose to pay profits to yourself.

What normally happens is that as a limited company:

  • You set yourself a salary, which allows you to plan how much income tax you pay together with your NI contributions.
  • You pay corporation tax.
  • You use the remaining profits as you want, either opting to pay them out as dividends or leaving them in the company account until you want to extract them or you close down.

You, therefore, have lots of room for planning how much you earn, both through income and dividends. This gives you flexibility in terms of payable taxes, which often means you get more of the money you earn in your pocket.

The situation is different with an Umbrella Company because you are effectively just an employee. You’ll receive a salary based on the contract you’ve made as well as receive payments for any other pre-agreed costs. You won’t have much leeway in setting your income or taking advantage of the above tax planning options.

In most cases, your potential pay will be higher if you operate a Limited Company than an Umbrella – especially if your annual income is beyond £60,000. But you could benefit more even if your income is lower. Listen to the Taxman’s calculations show that even with an annual income of £30,000, the potential pay for a limited company is 75% compared to 70% for umbrella companies.

The potential gain comes purely from your ability to plan and control your income. With a Limited Company, you pay yourself a salary below the income tax threshold and keep your taxes minimal. Instead, you’d take dividends and only pay tax on those.

What about IR35 and its Impact on Limited Companies vs. Umbrella Companies?

One thing you have to be mindful about is IR35, which can have a significant financial impact on your earnings and make your decision between setting up a Limited Company and Umbrella Company slightly trickier.

IR35 is a set of tax legislation that simply determines your tax position with HMRC. It covers all business sectors and specialisms and it’s used to identify if your contracts fall inside its scope or not. If they do, you will be taxed as though you’re an employee and you won’t be able to use all the tax advantages mentioned above, even if you are set up as a Limited Company. In effect, in the eyes of HMRC, you’ll be an employee, not a contractor. This means that you might be better off working through an umbrella company because the other company already deals with your tax affairs and therefore, HMRC doesn’t have to question its position. You can read more about IR35 from our previous blog post.

Knowing if your contracts would be caught by the scope of IR35 is complex and difficult to determine. That’s why it’s helpful to consider talking to a professional advisor to ensure you don’t end in conflict with HMRC.

Get Help with Tax Planning and Choosing Your Business Model

On the onset, setting up a Limited Company makes a lot of sense and can give you a lot more control and flexibility. It can, in most cases, be better financially as well. However, it’s important to evaluate your specific situation and the types of contracts you have to make sure you choose the right business model.

We at Devonshire Green have experience helping independent contractors with their tax planning. You can contact us today to see how we could help you choose the right business model and help you keep more of what you earn.