Forming a limited company or utilising umbrella companies for freelance workers

(BSM). Submitted on Tue, 26 Jul 2011

Tax shouldn't be taxing, as the slogan goes, but for most contractors and freelancers it usually is. Choosing the right business model to suit your working life is important, but needs careful consideration. The tax system in the UK is under review - and the coalition government has made it clear that the tax system for small businesses needs streamlining. Historically many self-employed contractors have made use of the Limited company to maximise their income and lessen the impact of tax. However, IR35 legislation sought to close some of the loopholes in the tax system, but has been widely criticised and may face suspension in the near future. Alternatives to forming a limited company include working as a sole trader or using the services of an umbrella company. Making the decision between these models is never simple and with changes in the air freelancers remain in a difficult position.


Disguised employees
In the past forming a limited company made a lot of sense. The reason that this was 'tax effective' - the almost invisible line between effective and avoidance is the problem here - was that contractors did not have to take all income as salary, but split it between salary and dividends; the latter having less tax liability. This type of efficiency was exactly what IR35 sought to remove. Many contractors work as 'disguised employees' - working for one client as if they were employed by that client alone. For clients this system gave flexibility in terms of staffing - while for the contractor running their own limited company meant that what was effectively 'salary' could be re-organised into salary and dividend payments.
Suitability of Limited companies
Forming a limited company works best for contractors who fall outside of the IR35 regulations. Those who work for a range of clients and cannot be viewed as 'employees' of any single employer can still take advantage of forming a limited company. If you do fall into this category you can genuinely take advantage of the benefits of splitting income into salary and dividend payments. One small caveat - HMRC are fonder of the word 'probably' than lager marketing teams - so always take advice from an accountant.
Umbrella companies
If your working pattern means that you are forced to take all income as salary - i.e. you fall within the IR35 regulations - normally the most effective alternative to forming a limited company is to use the services of an Umbrella company. These effectively employ the contractor and run PAYE services as any standard company would. The contractor instructs the Umbrella company to invoice the client or agency they work for and tax and NI contributions are then dealt with by the Umbrella company. This can make the art of tax far less taxing for individual contractors or freelancers whose main source of income is with one single company.

 

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Whatever your circumstances, forming a limited company or using an umbrella company can make self-employment far more straightforward. Before making the decision take advice and consider the best options for your circumstances and your business.

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