Caught inside IR35? Operating through a limited company remains the best option

As a contractor, you can operate either through your own limited company or under a PAYE umbrella company. Both options offer many pros and cons, depending on your personal circumstances. As an independent professional, it’s important that you’re continually assessing the options to find what best suits you. If you find yourself working inside IR35, for example, you might be wondering which structure option would make the most financial sense for you.

Here’s why operating through your own limited company remains the best option, regardless of your IR35 status.

Limited Company or Umbrella Company – what’s the difference?

Limited companies

With a limited company, you are the director of your own private business. You have complete autonomy of how you work and who you work with. As a director, you are fully in control of your own company and its financial affairs – this allows for greater opportunities for tax planning including drawing dividends, claiming expenses and making pension contributions. The downside? While you have all the pros of being a director, you also have the additional responsibilities to HMRC and Companies House; which of course includes paperwork and financial management. This problem is easily solved by appointing a specialist contractor accountant – which typically costs a set monthly fee equating to around £1200 a year.

‘The majority of contractors work through their own limited companies for a reason. The tax advantages of working this way outweigh any other compliant method and you remain in control of your own finances. Umbrella companies offer higher risk and lower tax efficiency than limited company operation.’
– Rowena Barnwell, FCCA – inniAccounts Director of Client Services

Umbrella companies

When you join an umbrella company, you effectively become an employee of that corporation. You’ll receive a salary that has been subject to PAYE tax and National Insurance. The fact your payments are being handled by a second party introduces a level of risk; as you are reliant on the umbrella collecting money from your client or agent and using it to pay you.

Most reputable umbrella companies cost around £30 a week (£1,500 annually). However, there are usually additional costs associated. Services levied by umbrella companies can reach as much as 9% of the value of a contract. Many firms insist on contractors agreeing to a minimum level of charging or billable time; so the price can fluctuate (unlike accountancy fees which use set prices regardless of turnover). The benefits? Your financial affairs are handled by the umbrella; so there’s less admin, paperwork and financial management. Most weeks you’ll merely be submitting a timesheet, and the company will take care of the rest.

Assuming all your contract work is outside IR35 and your annual gross contracting income is around £55000 (with £1200 spent on either accounting fees or umbrella services). Your typical annual take home pay from an umbrella company will be around 65% of your income. With a limited company, this increases to approximately 76%. This doesn’t include the many tax planning benefits available to limited companies.

Working inside IR35

If any of your contracts fall within the off-payroll rules, you’ve probably heard that you might be better off under an umbrella. This is because IR35 doesn’t impact umbrella companies. Contractors in umbrellas will already have PAYE tax, and National Insurance deducted from their salaries; as if they were a standard employee, so there’s no additional requirement. However, this leaves many contractors out of pocket.

Assuming all your contract work is inside IR35 and your annual gross contracting income is around £55000 (with £1200 spent on either accounting fees or umbrella services). Your limited company take home will decrease to approximately 61%. As such, you may find there are marginal gains from working through an umbrella. However, if only half of your income comes from contracts inside IR35 your limited company take home increases to approximately 69%. This doesn’t include the many tax planning benefits available to limited companies.

If your contracts are not permanently inside IR35, a limited company outweighs the benefits of an umbrella. As well as remaining more tax-efficient, a limited company allows you to keep risk-free control over your business and to flexibly accept contracts both outside or inside IR35. Converting to an umbrella company would mean that any future work you undertake that’s outside of IR35 would leave you significantly out of pocket. The fairly negligible percentage difference even for those who predominantly work inside IR35 may also not be worth the higher risk associated with umbrellas, the admin fees or losing out on many of the attractive incentives a limited company still offers (such as being in complete control of your working hours and the available tax planning opportunities).

Ensuring compliance
If you do decide to make the change to an umbrella company, we’d advise doing your homework to ensure they’re compliant. Some umbrella schemes promise unrealistic tax savings. Remember – if it appears too good to be true, it probably is!

Operating through a limited company

While umbrella companies remove any question of IR35, for many contractors, they can’t compare to having your own limited company. Limited companies remain the most viable option for keeping control of your day to day business, managing your finances and returning home with more in your pocket. The tax advantages of working this way continue to outweigh any other method.