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Limited company or Umbrella – deciding on a payment structure

 

First time contractors have two options for setting up a payment structure: Limited company, or umbrella company.

With a one person limited company structure the contractor is the director of the company and in full control of all company transactions. As director they are responsible for compliance with all company and other statutory issues, including company law requirements to file accounts and returns to Companies House, calculation and payment of corporation tax liabilities, payroll calculations and returns and various other statutory and other Government requirements. As director they raise all company invoices, run a simple accounting system to record transactions and appoint an accountant to deal with accounts, taxation and payroll matters.

With an umbrella company solution the contractor would not be a director or the responsibilities associated with running a limited company. The umbrella company provider would take care of all accountancy and taxation matters and also deal with all administration matters.

The contractor completes a timesheet and forwards it to the umbrella company, who then invoices the agent. Following payment by the agent to the umbrella company, a payment is made by the umbrella company to the contractor.

 

 

Limited Company – Advantages

 

Complete control of all transactions and company matters.

Contractor can be seen to be “representing” the company and “running a business” with its own trading name.

Full control of revenue. Paid directly into the company bank account, rather than passing via an umbrella company bank account.

Faster payment and administration process due to direct control, assuming the contractor deals efficiently with all transactions.

Smaller tax burden (higher percentage net pay) for contract revenue earned outside of the IR35 legislation.

 

Limited Company – Disadvantages

 

Main disadvantage is the amount of administration/paperwork arising, particularly in the late filing/payment penalty culture.

Responsible for day to day issues as invoicing, keeping a simple accounting system and fully liaising with their accountant, to ensure all forms, returns and accounts are filed by the due dates.

Many contractors, particularly first timers do struggle with these responsibilities.

 

 

Umbrella Company- Advantages

 

Avoids time and trouble of running a limited company. After a simple set up, the contractor completes timesheets and forwards to the umbrella company.

Knowledge that money is lodged into their bank account and documents are sent to them explaining how the payment is calculated. No need to be involved with running a spreadsheet, VAT returns, payroll matters, company accounts, taxation, etc.

For short term contractors, a main advantage is not having the costly process of forming a company and then arranging for it to be dissolved.

 

 

Umbrella Company- Disadvantages

 

The contractor will by definition not be running the company and will therefore be using it simply as a service to process transactions.

The contractor cannot represent themselves as running their own independent business, through which they can make policy decisions, take risks or act as company director.

There is inevitably some delay in the contractor receiving their money, since it needs to pass through a third party account before reaching them. This is down to the efficiency of the umbrella company.

There is an element of trust on the part of the contractor, since their money will be passing through the third party umbrella company bank account.

For contracts earning revenue outside IR35 there is a significantly higher tax burden than using a Limited Company – due to the Managed Service Company legislation (introduced in 2007 Budget).

 

 

In making a decision, the contractor should consider the following criteria:

 

IR35 status: If the majority of the contracts are likely to be outside IR35 then from an tax point of view the Limited Company is the sensible option for long term contractors.

How important is it to control the company? – if important, take the one person company director route.

How important is it to be a company director for presentation/status with third parties? – if it is important, then the one person company should be taken.

Attitude to administration, including dealing with forms, returns, correspondence with accountants and other third parties, spreadsheets, VAT returns etc. – if it is no problem, then take the own company route but if it is likely to be a problem, then the umbrella route would be preferable.

if it is a long term contract, a one person company may be preferable. If it is short term or dependent on factors which may change in the short term, then an umbrella company solution may be preferable.

If the decision to go “own company” or umbrella is a difficult one for a first time contract, then it would be best to go with the umbrella company solution for at least the short term. The reason for this is that it is very simple to leave an umbrella company and start up your own company but very much harder in terms of administration and expense to go from your own company to an umbrella.

 

 

IR 35 – What is it?

 

Also known as the Intermediaries Legislation, it is concerned with your employment status (employed or self-employed) for tax and national insurance purposes. At its most basic, it means that if you provide your services to a third party (the client) through a limited company (an intermediary) then you have to consider IR35 for each and every contract you undertake.

IR35 is concerned with your relationship as an individual with the end client. To be inside IR35 means that this relationship is effectively one of disguised employment and you will have to pay employed levels of tax and NIC on your income. If the relationship is not disguised employment and is outside IR35, you are free to account for your own tax and NIC on your income through your own company. The net result is that being inside IR35 usually costs you a lot more.

Tax/NIC status – how is it decided? There is no statutory definition of employment or self-employment. We have to look to the courts and the decisions that have been made over the years where the employment status of a person has been decided. These decisions relate to tax, NIC and also employment law rights including unfair dismissal cases and holiday and sick pay cases etc. To decide status it is necessary to look at all the terms and conditions of your relationship. This includes any terms set out in written contracts as well as what happens in reality; the working arrangements.

Where an agency is involved there is often no contractual relationship between the worker and the end client and in some cases there can be multiple parties involved and all the terms and conditions between all of the parties need to be considered.

It is necessary to consider IR35 each time you enter into a new arrangement or contract. This is because IR35 concerns relevant engagements so for example you could undertake five different contracts in a year and three could be found to be inside IR35 and two outside. It is even possible to provide services to the same end client for two different projects and come up with one inside IR35 and one outside IR35 as the terms and conditions and the working arrangements could be different.

There are some minor differences between the tax and the NIC legislation but essentially there are three requirements for the legislation to apply and all three have to be satisfied before the worker can fall into the IR35 rules.

The first requirement is that the worker personally performs (or is under an obligation personally to perform) services for the client.

The second is that the services must not be provided directly by the worker to the client but via an intermediary.

The third is that the circumstances (terms and conditions and working arrangements) are such that if the worker provided the services directly to the client the worker would be regarded as an employee of the client.

It will be a matter of fact whether or not you carry out the services personally and satisfy the first condition as will the presence of an intermediary thereby satisfying the second condition. It is, of course, the third condition that poses the problem which is showing that the terms and conditions and working arrangements do not amount to disguised employment.

 

What factors are considered when deciding IR35?

 

The main factors considered when deciding IR35 status are as follows:

  • Extent and degree of control exercised by the client over the worker.
  • The worker’s right to engage helpers or substitutes.
  • Mutuality of obligations between the worker and the client.
  • Financial risk of the worker.
  • Provision of equipment.
  • Basis of payment of the worker.
  • Personal factors
  • The existence of employee rights.
  • Termination of the contract.
  • Whether the worker was part and parcel of the client’s organisation.
  • Exclusive services.
  • Mutual intention.

This list is not exhaustive and Case law shows not to treat this as a checklist to run through mechanically. Instead they are the factors that go towards painting the picture whose overall effect must be evaluated.

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