Limited or umbrella? The pros and cons

As a recruitment agency that deals in contract jobs, we’re often asked which is better, an umbrella company or a limited company? Here we weigh up the pros and cons of each to help you decide which is right for you.

Deciding between a limited or umbrella company for contracting is a question that often comes up when workers are thinking of becoming contractors for the first time, or considering switching from one to the other due to a change in their circumstances. There are a number of factors to consider, largely based on how much you earn and how much paperwork you are prepared to do, although these are not the only aspects to think about. Those earning below £17 per hour often find it more beneficial, in terms of tax efficiency, to use an umbrella company, however there is no one-size-fits-all approach.

Some service providers may recommend one method over the other, as it is in their interests to do so but rather than push you in one direction or the other, we’ve put together a list of pros and cons of limited and umbrella companies in our best effort to remain impartial and only present you with the facts to help you make your mind up for yourself.

Pros of having a limited company

• Total control: As a Director of your own company, you have total control over all transaction and revenue, including the handling of invoicing.
• You decide how you want to be paid: Being self-employed you will pay yourself a salary. If you are on a high tax rate it is possible to leave money in the company account for a period of time so that it can be drawn later at a lower tax rate.
• Credibility and flexibility: Having a limited company with a trading name can enhance your standing when applying for new assignments. It also allows you the flexibility to undertake ad-hoc work for another vendor should you wish to do so.
• Tax exemptions: As a counter to higher rates of personal income tax on your salary, being a director of your limited company will mean you receive dividends, which you do not pay National Insurance on. You can potentially split the company shares between yourself and your partner so you can both use your personal tax allowances and base rate bands. Furthermore, you can register for VAT at a flat rate which may also increase how much you can take home.
• Wider range of expenses: Expenses are not taxed and provided you are outside IR35 legislation, you can claim for a wider range than those inside IR35 or those working  through an umbrella company. These include, company formation and accountancy fees, travel and accommodation, phone calls, postage, office equipment, insurance, business entertainment and National Insurance and pension contributions.

Cons of having a limited company

• Managing administrative tasks: Setting up a limited company and related business bank account can take time and require you to complete a fair bit of paperwork. You must also be organised and set yourself reminders to file returns with HMRC and Companies House, including an end of year self-assessment and your P35 and P60 tax forms. You risk being hit with tough penalties if you fail to fulfil these obligations.
• IR35 legislation: This legislation applies to contractors and affects the amount of tax and National Insurance that you will be required to pay. You must make sure you are on the right side of the law with this legislation so it may be necessary to speak to a specialist accountant to determine whether it applies to you. If you are caught within IR35, you can expect to pay more tax and national insurance and claim for fewer expenses.
• Accountant fees: Limited company accounts are required to be signed-off by a qualified accountant which will incur an annual fixed cost. If you choose to do the administrative side of your books yourself, you must be able to keep an accurate record of your invoicing and VAT.
• International constraints: There are restrictions on limited companies operating outside of the country of registration, which can often mean that it is not a viable option if you intend to contract abroad.

Pros of using an umbrella company

• Non-committal: If you are only planning to interim as a contractor or are not sure that you want to commit to it in the long-term, it may not be worth the investment, financially and administratively, to set up a limited company. Using an umbrella company gives you the freedom to change your mind or return to permanent work when your assignment comes to an end.
• Relatively admin-free: An umbrella company will take care of administrative tasks for you. You will of course be responsible for getting your timesheets signed, but they will take care of invoicing, chasing for payment, compliance with legislation and calculating and managing your tax and National Insurance contributions for you.
• Employee benefits: You will pay tax as you earn (PAYE) instead of receiving a large bill and some companies even offer full employment rights, such as sickness and holiday pay and maternity leave. In addition, professional liability insurance is usually provided and you are not affected by IR35.

Cons of using an umbrella company

• Fees are deducted: An umbrella company will take a percentage of the money that you earn before making payment to you. Contractors often only receive around 60% of their earnings.
• Lack of control: By using an umbrella company, you are putting faith in them to handle how your invoices are dealt with. Additionally, with more parties involved, payments can take longer to reach you.
• National Insurance Contributions: If you contract through an umbrella company you will pay both employee National Insurance contributions and those of the employer.  
• Expenses: Although you are entitled to claim for associated business costs including travel and accommodation and pension contributions, administration expenses are fixed at 5% of your contract income.
• Single vendor contract: If you intend to undertake ad-hoc work for multiple vendors simultaneously, this would require additional contract under an umbrella company, making it far more difficult and costly than it would be with a limited company.

Have we missed anything? Tell us if you’ve found this guide helpful or have your say in the comments below.