PAYE, Umbrella, or Limited Company?
Which Structure Suits UK Contractors?
If you're a contractor in the UK, you'll have a few decisions to make as your business grows, including picking a business structure. Choosing the right business structure can feel like a daunting process, and we understand why. Whether you're just starting out or looking to switch up your current contracting setup, understanding the key differences between PAYE, umbrella and limited company structures is key for both your financial success and your peace of mind.
At Go Limited, we know that each option comes with its own set of advantages, tax implications, and administrative responsibilities, and we know that what works for one contractor may not work for another. Below, we've taken a look at each structure, comparing the pros and cons of each.
PAYE vs. Umbrella vs. Ltd Companies
When it comes to deciding which business structure is best for contractors in the UK, it's important to consider the main types available. There are three main ways to approach working in the UK; PAYE, through an umbrella company, or by setting up your own limited company. There are pros and cons of each of these, which is why not all contractors pick the same route. Whereas some contractors choose to keep things simple by using the PAYE system and an umbrella company, others want to capitalise on the benefits of contracting through a limited company.
PAYE (Pay As You Earn) - This is the traditional employment structure where your employer deducts taxes and National Insurance contributions (NICs) before you receive your pay. It's how you'll be paid if you're employed, rather than self-employed. As a contractor, using the PAYE system means that you're essentially an employee of the recruitment agency or client that you're working for.
Umbrella Company - An umbrella company acts as the 'middleman' between you and your client, employing you on a PAYE basis, as if you were an employee. The umbrella company deducts taxes, NICs and other relevant expenses before paying you. Though you're a contractor, your income is treated in the same way as traditional employees.
Limited Company - Setting up and trading through a limited company means that you are running your own business. You're the director, you're in control and all of your contracting is done through the business. You pay yourself a salary and can take dividends. This is different to PAYE, where dividends are not an option. When you have a limited company, you're in charge of your own taxes, bookkeeping and other business responsibilities.
Each structure has slightly different tax implications, administrative requirements and levels of flexibility, and they're by no means created equal. This is why it's important to compare all three options before making a decision, as you'll want to approach contracting in the way that works best for you.
Umbrella Company Versus PAYE Contracting
A lot of contractors, to begin with at least, view working under an umbrella company and employer PAYE in the same way. Though they are similar, there are a few key differences.
With PAYE, you are employed directly by an agency or client, which means they're responsible for ensuring that your taxes and NICs are deducted. You go to work as an employee, receive a payslip and that's that. With an umbrella company, you're employed by the umbrella company, not your client or agency, and this can provide an additional layer of support and compliance. It's a way to enjoy the benefits of contracting, without having to be a full-time, permanent employee of one employee, and without having to deal with the admin side of contracting yourself. You're treated as an employee for tax purposes, but nothing more.
In terms of admin, PAYE contracting is relatively straightforward, as there's very little to manage on your part. The agency or client handles most of the paperwork, and you can focus on the day-to-day of the job. But, whilst an umbrella company also handles much of the admin for you, they also provide additional services, such as helping you to claim expenses if you have any.
Compare an Umbrella and Limited Company
Of course, they're not the only contracting structures available. For a lot of contractors, setting up a limited company is an option, and it's a route that a lot of contractors end up taking. If you're considering setting up a limited company over working under an umbrella company, there are some key differences to keep in mind.
Key Differences Between Umbrella and Limited Companies
- Tax efficiency - One of the main things that you'll notice when comparing an umbrella and limited company, is that limited companies can often offer greater tax efficiency. With a limited company, you can take a combination of salary and dividends, which may result in lower tax liabilities compared to being paid entirely through PAYE. This is because dividends are taxed at a lower rate than salaried earnings.
- Control - A key advantage of a limited company versus an umbrella company is the greater level of control that you have over your income. You can decide when and how you pay yourself, whether that's in salary form, dividends or a combination of the two. With an umbrella company, you're typically paid on a regular payroll cycle, on a regular day and with less flexibility.
- Admin - Running a limited company requires a fair amount of administrative work, including accounting, filing tax returns and managing VAT, if you're VAT registered. This isn't the case with an umbrella company. Also, depending on your accounting abilities, you might need to hire an accountant to ensure that you comply with HMRC regulations and to handle the more complex side of limited company finances. An umbrella company manages all this for you, but they do usually charge a fee for their services.
- Costs - There's an additional cost that comes with working under an umbrella company, as these companies charge a fee for their services. Though small, this can add up. But, setting up a limited company might mean you need to hire a limited company accountant. These are both costs to consider, but they can be somewhat offset with a limited company. As a limited company contractor, you can pay yourself in dividends, which are taxed at a lower rate. You can also claim tax-deductible expenses, further reducing your tax bill.
- Liability -
A limited company offers the protection of limited liability, which means that your personal assets are separate from your business finances. If the business takes on a debt or loan and it can't repay, your personal assets - including savings and property - are protected, and only the business is at risk. But, an umbrella company's structure doesn't offer this protection, as you're still technically an employee of the umbrella company.
How Much Will You Take Home? Umbrella vs. Limited Company Pay
When you're weighing up the pros and cons of an umbrella company versus a limited company, the amount of money you could make is sure to be a major consideration. When comparing pay between the three structures, it's essential to consider the various costs involved, and how much your take-home pay could be.
- PAYE - Your take-home pay is usually lower on PAYE because there's less flexibility in how you're taxed. You pay tax and NICs based on your full income, with no chance of offsetting it with expenses or dividends. It's a simple and straightforward route, but it's less cost-effective.
- Umbrella Company - You'll pay a small fee to the umbrella company for their services, which reduces your take-home pay. But, you may be able to claim certain business expenses, which can increase your income slightly. However, these expenses are limited.
- Limited Company - A limited company usually allows you to be more tax-efficient. By paying yourself a combination of salary and dividends, you can lower your tax liabilities. This is because a salary is taxed at a rate of 20%, but dividends are taxed at less than half of that. Though you'll have to account for additional costs - such as accounting services, business insurance and other operational expenses - reduced take-home pay tends to offset this.
FAQs
What is the difference between PAYE, Umbrella, and a Limited Company for contractors?
- PAYE (Pay As You Earn): You are employed by an agency or employer and taxed directly through HMRC. Your tax and National Insurance (NI) are deducted at source, and you have no administrative responsibilities.
- Umbrella Company: You work as an employee of an umbrella company, which processes your payroll and deducts taxes, NI, and their own margin. You receive a payslip just like a normal employee.
- Limited Company (LTD): You run your own business as a director, taking income through salary and dividends. You handle your own taxes, but you can benefit from tax efficiency if structured correctly.
Which option is best for tax efficiency?
- A Limited Company is usually the most tax-efficient, especially for higher earnings, as you can take advantage of lower tax rates on dividends.
- An Umbrella Company can be more convenient but is less tax-efficient due to employer NI and umbrella fees.
- PAYE is straightforward but results in the highest tax deductions as there are no tax-saving options.
Can I claim expenses under each structure?
- Limited Company: You can claim a wide range of business expenses, including travel, equipment, and software, reducing taxable profits.
- Umbrella Company: You can only claim limited expenses, and only if your contract is not under Supervision, Direction, and Control (SDC) rules.
- PAYE: No expenses can be claimed, as you're taxed as a standard employee.
What happens if I fall under IR35?
- Inside IR35: You pay taxes similar to an employee, meaning a Limited Company loses most of its tax benefits.
- Outside IR35: A Limited Company remains the best choice for tax efficiency.
Umbrella and PAYE are unaffected by IR35, as taxes are already deducted like an employee.
Which option has the least admin?
- PAYE: No admin; the agency/employer handles everything.
- Umbrella: Minimal admin; you submit timesheets, and they handle payroll.
- Limited Company: Highest admin; you need to file accounts, submit tax returns, and comply with HMRC regulations.
What are the key costs to consider?
- PAYE: No additional costs beyond standard tax deductions.
- Umbrella Company: Deducts an admin fee (~£20-£30 per week) plus Employer NI and Apprenticeship Levy.
- Limited Company: Accountant fees (~£600-£1,500 per year), corporation tax, and dividend tax apply.
Approximate Earnings Calculation for £75,000 Under Each Structure
Below is a rough estimate of take-home pay under each structure for the 2024/25 tax year:
- Income StructurePAYE (Employee)Umbrella CompanyLimited Company (Outside IR35)
- Gross Income £75,000 £75,000 £75,000
- Income Tax & NI ~£22,300 ~£24,000 (incl. Employer NI) ~£9,000 (Corporation Tax)
- Umbrella Fees N/A ~£1,500 per year N/A
- Net Dividend Tax (if LTD) N/A N/A ~£3,000
- Estimated Take-Home Pay ~£52,700 ~£49,500 ~£63,000
Key Takeaways from the Calculation:
- Limited Company (Outside IR35) provides the highest take-home pay (~£63,000).
- PAYE is straightforward but results in a lower take-home (~£52,700).
- Umbrella Company is the least tax-efficient (~£49,500) due to fees and Employer NI deductions.
Note: These figures are estimates and may vary based on personal allowances, tax code, pension contributions, and specific company setup.
At Go Limited, we know that contracting can be confusing, especially when it comes to deciding how to approach the day-to-day running of your business. For some contractors, the ease that comes with PAYE and umbrella companies is hugely appealing. They enjoy the convenience, easy and extra time that comes with having another company handle the administrative and financial side of contracting. But, more often than not, setting up a limited company comes out on top. With a lower tax rate, higher take-home pay and limited liability, contracting through a limited company puts many contractors in prime position for business success.
