Pro’s & Con’s of Contracting Through a Limited Company

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2 April 2021
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20 April 2021
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A common dilemma for contractors is deciding between working through an umbrella company or as a director of a limited company. Both contracting methods have their advantages and disadvantages, which begs the question – which is better for your business? For Umbrella Options’ breakdown of the pros and cons to contracting via a limited company, read on.

What is a limited company?

A limited company offers contractors a tax-efficient means through which to work. By using a limited company, you will invoice clients directly without the use of an intermediary. This could save you money you might otherwise spend in fees. Additionally, you can receive your payment in two forms – a salary and dividends. Dividends are taxed differently from salaries, being subject to capital gains tax rather than income tax. Alternatively, you could decide against paying yourself dividends, instead leaving the funds in the company. These factors have contributed to limited companies being viewed as the most tax-efficient for contractors. However, these benefits do come at a cost. If you choose to form a limited company, you will be its director. Therefore must accept increased responsibilities, for example keeping records and filing your accounts with the HMRC.

Advantages of a limited company

  • One of the main draws to contracting through a limited company is its tax efficiency. Unlike alternatives, directors of limited companies can pay themselves dividends alongside the typical salary. Generally, contractors working through a limited company will pay a small salary while receiving the rest of their income in dividends. This is done because dividends are not subject to National Insurance contributions. The smaller salary of course being subject to a smaller tax rate. Funds can also be left in the business until the next tax year in order to avoid exceeding tax thresholds. Additionally, shares of the company can be gifted to a spouse, benefitting from a partner’s tax allowances.
  • You are the director of the company. Therefore you have complete control over business finances and administration, in addition to the direction of the company.
  • As the company director, your liability as an individual is limited. If your company were to suffer financially, your personal assets and finances are off-limits. One exception to this is if you guarantee a loan personally.
  • You can use your business’ shares to fundraise by attracting investors or to benefit from tax allowances by gifting them to a spouse. Keep in mind that by gifting shares to family members other than a spouse or selling them, the value of the shares will be subject to capital gains tax, as it is considered disposal.
  • You have the option to sell your company as it exists as a legal entity.  This could be useful if you decide to wind things down. Alternatively, you have the option to pass ownership on, should you prefer.

Disadvantages of a limited company

  • Being the director of a limited company offers more freedom than alternatives but requires more work to manage. Unlike working with an umbrella company, limited companies will involve a higher administrative workload. Though this can be mitigated by hiring accountants or other assistants.
  • You are obligated to provide the HMRC and Companies House with your Annual Accounts and to complete a Confirmation Statement, otherwise known as the Annual Return.
  • You are responsible for your company’s accounts and records, even if you have hired someone to handle record-keeping for you. It is also your responsibility to ensure the records are submitted accurately and quickly.
  • Running a limited company carries with it some costs. Some of these are one-time or initial startup costs, like registration fees, while others are recurring, such as administration and record filing fees.
  • As you will contract through your limited company, it is important to be aware of IR35. If you are found to be working within the IR35 legislation, yet have not acted within the rules, you could be subject to considerable fines. If you are unsure, it is always a good idea to get professional advice before agreeing to a contract.

Should you contract through a limited company?

Working through a limited company certainly has its advantages, however, it is not a one size fits all solution for contractors. For more experienced contractors prepared to take on increased responsibility and more administrative work, the potential cost savings and tax efficiency could well be worth it. For newer contractors with less experience in the industry, this increased level of responsibility and work may not be a recipe for success. Instead, the security offered by working with an umbrella company could be an ideal entry into contracting, with the formation of a limited company always being an easily implemented option. As with everything in contracting, it is very dependent on your situation, so be sure to consider how the available options mesh with what is best for you.

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