In order to make an informed decision, the following should initially be taken into consideration: how simple is it to administer? How private do you want your company to be? What losses and liability are you prepared to take? But most importantly, and the question at the forefront of everybody’s mind when embarking on their journey is, how easy is it to access your hard earned cash, and what tax savings can you make from it?
A limited company is the most commonly used set up for contractors; this is because the payment package for directors or shareholders of small companies tends to consist of a small salary and large dividends. There are plenty of accountants who would be willing to help with the formation of a company, general accounts and tax returns. Dividends are favourable because they attract no National Insurance and they are taxed at a lower rate of income tax than say, a sole trader income. Limited companies will, however, have to be careful of IR35 tax legislation if they want to operate in this way.
An alternative would be to contract via an umbrella company, although the financial benefit is diminished.
An umbrella company acts as an employer to agency contractors who work under a contract assignment, sometimes through an employment business. It issues invoices to the employment business or client, and when payment of the invoice is made, will typically pay the contractor through PAYE, after taking a proportion for themselves. This is with the added benefit of offsetting some of the income through claiming expenses such as travel, meals, and accommodation. In this respect, streams of fees have already been paid to various companies before you get to see any income for yourself. The use of umbrella companies has increased however, since the government introduced IR35 legislation, which has somewhat perturbed contractors ever since, to say the least.
If you are looking for a less complicated option, or have a relatively low income, you may be interested in a sole trader set up.
A sole trader describes any business that is owned and controlled by one person. They may, however, employ workers as the ‘sole trader’ definition does not mean that you have to work alone. Sole traders do not have a separate legal existence from the business and as a result, the owner is personally liable for the firm's debts. If incurred, these may have to be paid by the business out of their own pocket, which could include their own personal assets such as their car, or even family home. End clients are less likely to take on sole traders in the IT industry, preferring to engage limited companies. This is because if under employment status HMRC consider the sole trader to be an employee and not a business in their own right, the majority of liabilities such as National Insurance would fall onto the end client. If they are a limited company, IR35 legislation would be applied and the limited company would be liable for all tax and National Insurance.
An offshore scheme is generally one to avoid, as HMRC are always finding a way to clamp down on the many loopholes concerning this sort of set up. This scheme works by a contractor entering into a contract of employment with an offshore employer, whilst still providing services in the UK. The contractor would receive a low salary, for example £10,000 per annum. This would be subject to UK income tax and National Insurance. The scheme provider will retain a large proportion of your income (usually 10-12%) and the remainder of the funds are provided in the form of a loan. These are usually seen by HMRC as unsuccessful tax avoidance schemes, and according to recent updates at the time of writing, are currently taking action against contractors who have used these schemes between 2008 -2011. As a result, IR35 tax loss insurers are very wary of covering such schemes.
Taking everything into consideration, a contractor working through their limited company is, and has always been, the most tax-efficient way of working legally in the UK.
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