Contractors’ Questions: Should I go ‘Ltd’ or umbrella in 2019?

Contractor’s Question: I’ve read about the advantages and disadvantages of a limited company but as a newcomer to contracting in 2019 -- my New Year’s Resolution is to strike out on my own, I still don’t know; should I go umbrella or limited company?

Expert’s Answer: As it’s topical right now (the government is proposing that umbrella companies be answerable to an enforcement body), let’s first look at umbrella companies.

Generally-speaking, if you’re on a short-term contract, earn less than £25,000 or you’re likely to be caught / inside IR35, then operating through an umbrella may be the best option for you, financially. You’ll be taxed as a PAYE employee would, so your NI and income tax would be deducted at source and sent to HMRC.

As an employee, your umbrella company will typically take care of the paperwork; you’ll just be submitting your timesheet. By operating through a brolly, there are no directorial duties attached or the administrative hassle of paperwork. If you’re looking for simplicity, operating through an umbrella may be for you.

Before I move on to outline the suitability of a 'Ltd,' be aware that IR35 reform in the public sector is now in force, and has been since April 2017. The reform means that if you’re working for a public sector body through your limited company, the responsibility for determining IR35 status will lie with the public sector body. As IR35 does not apply to umbrella company workers, the reform is not an issue for those contractors employed by a genuine PAYE umbrella company.

Before the reform, it was the contractor who was responsible for determining IR35 status. If found to be caught by IR35, you (the contractor) would be taxed as a PAYE employee would, the same as when operating through an umbrella.

By operating through an umbrella company, you will essentially become an employee which cuts out the step of any need to determine IR35 status. If you’re working on a public sector contract, operating through an umbrella may appear more attractive due to the operational simplicity.

So onto the ‘Limited Company’ (also known as a ‘Personal Service Company’ or ‘PSC’). If you’re on a long-term contract, running your contract through a limited company can be more financially-efficient, giving you more in take-home pay.

You’ll be able to benefit from the Flat Rate VAT Scheme and claim expenses such as travel, subsistence and accommodation. As a limited company contractor, making pension contributions is also a tax-efficient way of saving as there’s tax relief on any contributions that you make, subject to the £40,000 annual allowance.

As your own company’s director, you’ll take care of the day-to-day running of the business and you’ll be legally responsible for submitting the financial paperwork, including accounting paperwork. This is where a good accountant comes into play!

But IR35 reform was mentioned earlier, and it now needs to be mentioned again. In fact, it’s worth you noting that the IR35 ‘off-payroll rules’ (of April 2017 introduced in the public sector) are set to be extended to the private sector. The latest development is that this extension has been delayed until April 2020, according to an announcement at Autumn Budget 2018 and its supporting documents. This ‘off-payroll’ regime will only apply, however, from April 2020 to contractors whose private sector clients /end-users are medium or large-sized businesses.

The reform will mean that if you’re working on a private sector contract, with a large or medium-sized company, the end-client will be primarily responsible for determining your IR35 status as a contractor. Currently, limited company contractors working on a private sector contracts are free to determine IR35 status without the interference of the end client/agency, regardless of the size of organisation engaging them.

Unfortunately, if you’re caught by IR35, you will be required to pay NI and income tax, decreasing your take-home pay and increasing the complexity of your accounting. In order to determine the best operating structure, it’s worth calculating your take-home pay through both the limited and umbrella models, taking into account expenses incurred 'wholly for business use' (for PSCs).

Pending this reform, it is generally the case that by operating through a limited company, you can maximise take-home pay by tax planning and structuring the way you pay yourself through dividends and/or salary.

Your accountant will typically advise you on this but if you’re stuck, the ContractorUK Forum’s ‘Accountant recommendation thread’ goes through a list of professional tax experts who are well-positioned to help, seemingly from contractors who have actually used them or paid for their services already. From reading that thread, we believe it is worth taking a look at those professionals offering FreeAgent as part of their accountancy packages; with such software it really makes life easier when it comes to both invoicing and recording expenses.

Oh, and also with a limited company there’s the flexibility and freedom -- if that sounds appealing to you, then ‘Ltd’ could be the way to go.

The expert was David Tattersall of Handpicked Accountants, which connects businesses with local accountancy firms.