Umbrella Vs Limited

Introduction:

Often it is not possible to accept an employment position with an end client because they are looking for part-time contract resource without the added responsibility of also providing associated employment rights and benefits.

In these circumstances two popular options which are compared in this guide include: working via an umbrella company, or working via a limited company (providing that steps have been taken to ensure compliance with the Off Payroll Working (IR35) Rules, and the Managed Service Company Legislation).

For more information with regards to these rules and regulations, please see the additional guidance we have produced in these areas:

• QA Understanding the Off Payroll Working (IR35) Rules Guide

• QA Understanding the Managed Service Company Legislation Guide

OPERATING VIA AN UMBRELLA COMPANY

Umbrella Companies are limited companies which are administered via an umbrella company service provider (who is often also a recruitment company).

The sign-up process is very straightforward and can often be performed immediately, providing that the correct documentary evidence is available (such as proof of ID and address), as the umbrella company is treated as an employer and the worker is treated as an employee.  It is therefore a convenient solution for short term temporary contracts as the worker can join and leave the scheme at any time.

As the effective employer the umbrella company is required by law to provide a base level of services, such as the provision of payroll and holiday pay services.  They also typically help to negotiate the contract with the end client (by virtue of their role as a recruitment consultant).  However, they generally do not offer the same level of employment rights and benefits which would have been offered by the end client themselves in an employment position.  Therefore, where an employment position is available with the end client then this is often preferable, unless the level of remuneration offered compensates for the reduction in these right and benefits.

From an invoicing perspective the worker will submit timesheets on a periodic basis (e.g. weekly, monthly) to the umbrella company, which will then invoice the end client on their behalf.  The umbrella company will manage the credit control and collect payment from the end client.  Money received will be treated as employment income for the worker subject to PAYE and NIC, which they will deduct at source and pay over to HMRC on the worker’s behalf.

Employment expenses are allowable which are “wholly, exclusively, and necessarily” for the purposes of the employment.  And the umbrella company charges a service fee on a percentage or flat rate basis for the provision of their services.  A deduction is also typically made for holiday pay entitlements.  All of these expenses are treated as deducted “at source” before the application of associated PAYE / NIC employment taxes.  And as all pay is subject to employment taxes at source there is very little risk of future HMRC investigation or challenge from a compliance perspective.

Workers are provided with payslips summarising the resultant gross pay, taxation, and net pay positions and payment for the net amount is then arranged to the workers bank account.

All of these processes are managed on behalf of the worker by the umbrella company and the worker therefore has very little if any control over them.  Nevertheless, the process is therefore also very low maintenance and stress free for the worker, so is very attractive from that perspective.

SUMMARY

In summary working via an umbrella company is equivalent in many ways to working as an employee.  The primary difference being that the worker is employed by an intermediate umbrella company instead of by the end client, and therefore doesn’t have the same associated employment rights and benefits.  As an employee the worker has very little if any control over the invoicing, expenses, taxation, and payment processes as these are managed by the umbrella company on their behalf.  It doesn’t have the same tax efficiency benefits, but it is relatively low risk from the perspective of future HMRC investigation and challenge.  It is easy to join and leave the scheme and is an ideal option for short term low value contracts.

OPERATING VIA A LIMITED COMPANY

Choosing to operate via a limited company is definitely similar to using an umbrella company in certain aspects.  The worker still engages with the end client via an intermediary (the limited company) by which they are employed.

However, where the worker is also a director of the limited company it is important to understand that the onus is firmly on him / her to manage and control the company in a responsible and compliant manner.

In particular directors have legal responsibilities which they must be fully aware of, understand, and comply with.  QAccounting have provided a guide in this area entitled: QA Understanding Limited Company Director Responsibilities Guide.  And if you haven’t already read and understood the content of this, and you are either already a director of a limited company, or considering becoming one, then please do so without delay!

We also offer Accounting for Limited Companies to support directors in staying compliant, managing their obligations, and ensuring everything is handled correctly from an accounting and tax perspective.

We have also produced a detailed guide entitled QA Setting Up a Limited Company – Going Limited Guide, which explains all the steps of how to setup a new limited company and the thought processes that should be considered, so if you are considering using a company for the first time then definitely also read this!

Reading this guide will clearly highlight that when compared to operating via an umbrella company the preparation and administration involved in setting up a limited company is far more complex.  And it is similarly more complex and expensive to close a limited company in the future.  Therefore, this option is far more suitable for longer term contract opportunities, or where a worker will contract with a number of different end clients.

As the primary decision maker, it is essential that a Director negotiates contract terms with the end client on behalf of the limited company, and it is normally recommended to seek professional advice in this area to ascertain whether the contract is deemed to be “inside or outside IR35” with respect to the Off Payroll Working (IR35) Rules, taking into account both the terms of the contract and the working practices.

Likewise, while the director remains ultimately responsible for the accuracy and completeness of the books and records of the company, and making key business decisions.  It is normal to employ the services of an accountant to perform many of the other accountancy and taxation functions of the business.  And despite the huge scope of services available when hiring an accountant, it is often comparable in cost overall to what you would pay an Umbrella Company for managing you as an employee.

There are a number of areas though where operating via a Limited Company is different from a tax perspective.  And providing that you are operating in a compliant basis, there can therefore be opportunities for tax efficiencies in these areas:

• Expenses – In addition to the availability of “employment expenses”, businesses generally have greater scope for the deductibility of expenses by applying the “wholly and exclusively” for the purposes of the business test, instead of the “wholly, exclusively, and necessarily” test.  This means that accountancy fees and other genuine business expenses are allowable for tax purposes.
• Corporation Tax – Businesses must pay Corporation Tax (current rates vary between 19% and 25% based upon company profitability).  This is an “extra” tax not payable by a worker when using an umbrella company, but all wages, associated taxes (PAYE / NIC), and other business expenses are deductible before this is assessed.  Therefore, if the Director was to pay himself all profits as a salary then a similar or slightly improved situation could still be obtained (due to the greater deductibility of expenses).
• VAT – Businesses must charge VAT similar to an umbrella company worker where they have registered for VAT, voluntarily or because they have exceeded the Turnover thresholds.  But crucially businesses can take advantage of the Flat Rate VAT Scheme which can be more beneficial in those instances where a business incurs a limited expenditure which contributes to Input VAT deductions.
• Dividends & Timing of Payments – Where the director of the company is also a shareholder there can also be opportunities to extract some of the “after (corporation) tax” profits of the business via dividends which are taxed at a different (lower) rates to employment income and they not subject to employer’s national insurance contributions (NICs).  Furthermore, there is no requirement to pay out business profits in the financial years they are made as either a salary or dividends.  Which can be useful for retaining profits within the business, for the purposes of using these funds for business growth, or retaining them for withdrawal in future tax years.  For a more detailed discussion of the benefits of receiving dividends and the timing of payments see our Salary and Dividends Strategy Guide.

As in any situation where it is possible to take advantage of tax efficiencies there is greater risk of potential future HMRC investigation or challenge.  It is therefore essential to ensure that you are operating compliantly.

SUMMARY

Operating via a limited company is very different to using an umbrella company in a number of key areas.  There are similarities to the extent that the worker still engages with the end client via an intermediary company by which they are employed.  However, crucially the worker controls all of the processes and has far greater responsibilities as a Director to effectively and responsibly manage the company.  They also ensure that the company is being managed compliantly from an IR35 and MSC perspective to protect against potential future HMRC challenge.  However, providing that they manage the company responsibility there are greater tax efficiency opportunities available.  It is therefore an excellent option for longer term high value contracts, or where a worker has contracts with multiple end clients.

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