Comparing an umbrella company service to managing your own limited company

Quick guide to the differences between using the services of an umbrella company (See our guide: What does an umbrella company do?) and the advantages of running your own limited company. 

It all stems from the Managed Service Company (MSC) legislation, introduced in the 2007 Budget. Now, the only way an independent contractor can comply with current legislation is to set up their own own limited company or use the services of an umbrella company.

Limited Company

A limited company, in the United Kingdom, is a corporation whose liability is limited by shares. This is the most common form of privately held company. By setting up a limited company, you become a Director, responsible for the affairs of that company.

Pros

1. Tax efficient in some situations, assuming contracts are outside IR35.
2. Having complete control over the company and its operations.
3. Ideal for contractors with complex financial affairs.

Cons

1. Responsibility for maintaining accurate company records & accounts.
2. Responsible for ensuring compliance with all Company Law matters.
3. Having to raise invoices, and all aspects of credit control.
4. Maintaining an accurate accounting system.
5. Ensuring all company returns & accounts are filed by due dates.
6. Need for a reliable accountant.
7. Cost of insurance policies e.g. Employers & Public Liability & Professional Indemnity.
8. Requirement to complete an assessment for each tax year.

GoUmbrella's Ky Smith adds a friendly word of caution to contractors who are considering managing their own limited company:

• "Managed Service Company legislation has made the own limited company route higher risk; particularly for contractors who need third party assistance [eg an accountant].
• "If it is deemed that the company is a Managed Service Company, then the contractor will be liable for additional retrospective taxes.
• "Many contractors will struggle under these responsibilities; setting up and managing your own limited company should not be entered into lightly."

PAYE Umbrella Company

An umbrella company employs contractors who work under temporary contract assignments. The umbrella company issues invoices to a recruitment agency (or client) and will pay the contractor through PAYE.

All tax and National Insurance liabilities are deducted at source, making the umbrella company the safest & easiest way to be a contractor. Look here if you want an introduction to umbrella companies.

Pros

1. Great for first time contractors who want a quick & easy way to start contracting.
2. Ideal for contractors working on short term contracts.
3. The threat of IR35 is removed.
4. Removes the legal responsibilities of running your own limited company.
5. All legal, contractual and financial affairs are dealt with by the umbrella company.
6. No work no fees.
7. The umbrella company takes care of all accountancy, administration & taxation matters.
8. No chasing for payment of outstanding invoices.
9. Full employee status and entitlement to all statutory employment rights.
10. Umbrella company fees include a full range of insurance cover.

Cons

1. In some particular circumstances not as tax advantageous.

There are a number of factors to consider when choosing the right payment vehicle. There is no absolute right or wrong solution. Both payment structures are perfectly viable, but depend on working arrangements, circumstances & requirements.