7. Setting up your contractor company - Limited, Umbrella or PAYE?

Setting up your Company

Historically, the majority of IT contractors worked through their own Limited Companies. The tax advantages of working this way far outweighed any other method. With the introduction of IR35 these tax advantages may have been removed depending on whether you fall within the new IR35 rules or not. As a general rule, if you fall outside the IR35 rules then you will be most likely better off using a Limited Company, whereas an Umbrella Company would probably be more beneficial otherwise.

The options available to you are:

  • Setting up your own Limited Company
  • Umbrella Company
  • PAYE through the Agency

1. Setting up your own Limited Company

The vast majority of IT contractors work through their own Limited Company.

If you wish to set up your own Limited Company, you can use the ContractorUK Company formation service which enables you to complete the whole process online within a matter of minutes, and have your brand new Company ready to trade within a few hours. You can check to see if the name you require is available here also. Alternatively, you can apply for a limited company direct from Companies House (but this will take longer).

2. Umbrella Company

An Umbrella Company provides a ready made invoicing vehicle for contractors whilst also removing the administrative duties normally associated with contracting in the form of a Personal Service Company. The Umbrella Company normally issues invoices on the contractor's behalf, collects payments from clients/agencies, calculates tax and N.I contributions and pays the contractor their net pay direct to their personal bank account.

Traditionally, using an umbrella company was more expensive than running your own Limited Company, mainly because their charges included all the administration overheads, and they tended not to offer the same tax advantages. With the introduction of IR35 the tax disadvantages of Umbrella Companies have been reduced and a new breed of internet based umbrella companies have emerged.

You can look though our directory of umbrella companies to find a provider if required.

3. PAYE through the Agency

Some agencies allow you to become "PAYE" through their own payroll service.

This is the least tax beneficial option available to a contractor as you pay full tax and national insurance (NI) contributions on all your earnings. In addition this option does not allow you to claim valid business expenses which would help to reduce your tax and NI liabilities.

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