IR35 Challenges Explained
IR35 Umbrella Company vs Limited Company
As a contractor in the UK, regardless of the work you do and the industry you work in, you'll have the important decision of choosing the right business structure. There are popular options; working through an umbrella company or setting up a limited company of your own. While both have their advantages, the way they handle IR35 can make a huge difference to your take-home pay and overall tax responsibilities.
At Go Limited, we're knowledgeable about IR35, but we know not everyone is. There's a lot to think about as a contractor, and getting your head around IR35 can be daunting, especially if you're also trying to decide between an umbrella company and a limited company. We're here to help by breaking down the key differences between the two, exploring how IR35 applies to each.
What's the Difference Between an Umbrella and Limited Company
To make sure that you're clued up enough to make a choice between an umbrella company and a limited company, it's important to know the differences between the two, especially when it comes to IR35.
- Umbrella Company - As a contractor, you have the option to join an umbrella company. An umbrella company acts as a 'middleman' between you and your client. You become an employee of the umbrella company and you contract through them, providing the same services as before. Instead of sending invoices yourself and being paid by your client for the work you've done, the umbrella company pays you. They deduct income tax and National Insurance contributions (NICs) from your salary before paying you, meaning less administrative work for you. You can enjoy your take-home pay, knowing everything else has been handled on your behalf.
- Limited Company - You also have the option to set up your own limited company. With a limited company, you are a director and shareholder of your own business. You contract directly with your clients, as you would as a sole trader, but your business invoices them for the services provided. You are responsible for handling your own accounting, taxes, NICs and compliance with laws like IR35. There's a lot of responsibility that comes with running a limited company, but you also have greater control over your finances and tax planning.
As you can see, there are a lot of things that set umbrella companies and limited companies apart, but the biggest one is certainly the way in which IR35 is handled.
Umbrella vs. Limited Company: IR35 Differences
When you're deciding between whether to contract through an umbrella company or a limited company, you need to think about how IR35 applies. As a contractor, you can work inside or outside of IR35. If your contract falls inside IR35, it means that you are considered to be working as an employee, rather than as a contractor. This doesn't change the day-to-day of the work you do, but it does change how you're treated for tax purposes. When you're working inside IR35, you'll pay tax and NICs as if you were an employee. If your contract falls outside IR35, you are still considered a contractor, and so you benefit from more tax-efficient income.
- Umbrella Company IR35 - If you work through an umbrella company, IR35 isn't something that needs to confuse you. A lot of contractors find IR35 confusing, but working under an umbrella company means that you're considered to be an employee of that company. They will determine whether your contract falls inside or outside IR35, and they will make the necessary deductions from your pay accordingly. This means there's less risk on your part - after all, you won't want to get IR35 wrong - but it can also result in higher tax deductions.
- Limited Company IR35 - If you're contracting through a limited company, IR35 can be somewhat of a grey area, and it's something that a lot of contractors find ambiguous. It used to be your responsibility to know whether your contract is inside or outside of IR35. But, thanks to recent changes to the law, the responsibility for determining if a contract is inside or outside of IR35 now lies with the end client - either the client you're doing the work for, or the employment agency who's hired you on their behalf - and they need to treat you as such. If your contract is inside IR35, you'll face the same tax deductions as you would with an umbrella company. If your contract is outside IR35, you're likely to enjoy the tax benefits associated with operating as a limited company.
Inside and Outside IR35: The Pros and Cons
When you're a contractor in the UK, the difference between working inside or outside IR35 can significantly impact your taxes and earnings.
Working Outside IR35
The main advantage of working outside IR35 is that you're treated as a self-employed contractor. This means you can pay yourself through a combination of a small salary and dividends from your limited company, which is much more tax-efficient than being taxed as an employee. The ability to take dividends - which are taxed at a lower rate than salary, 8.75% compared to 20% - allows you to reduce your overall tax bill. As you can operate more tax-efficiently and keep more of your earnings through dividends, you have the chance to earn more money than if you were working inside IR35.
However, there are a handful of disadvantages. The main downside of working outside IR35 is getting things wrong in the eyes of HMRC. If HMRC deems your contract to be inside IR35, and not outside IR35 as you thought, you could face significant costs, including penalties. You need to assess and manage your contracts on a regular basis to ensure that they remain outside of IR35.
Working Inside IR35
Working inside IR35 is simpler in regards to admin and paperwork, especially if you work through an umbrella company. The umbrella company will handle your tax and NICs, taking care of all the deductions before you get paid. You don't need to think twice about it. An umbrella company will take care of the majority of business-related tasks, meaning that you don't have to manage your own accounts, payroll or taxes.
Of course, as is the case with working outside IR35, there is a downside or two to working inside IR35. When you're working inside IR35, you're treated as an employee for tax purposes, meaning that you'll pay the same income tax and NICs as an employee with a salary. This can lead to a significant reduction in your take-home pay. You won't be able to take advantage of dividend tax rates if you're working outside IR35. Working inside IR35 also means you're likely to have less control over how and when you work. More often than not, clients will dictate your hours, how you work and where you work. This can take away the feeling of being your own boss, something that a lot of contractors crave.
Is an Umbrella Company or Limited Company Best for Contractors?
There are a variety of ways to approach contracting in the UK, but choosing between an umbrella company and a limited company comes down to your specific needs, financial goals and how you want to run your business. What's best for one contractor, might not be best for another. This is why it's important to consider what you want from your business, and look at whether an umbrella company or limited company is more likely to provide that.
An umbrella company is ideal for contractors who want to keep things simple, the contractors that don't want to handle the admin of running a business. It's also likely to be a beneficial route if you only have short term contracts. If you're worried about IR35 compliance - and you don't want to run the risk of making a mistake - having an umbrella company to handle everything on your behalf can be a relief. However, the downside is that you'll likely pay higher fees and have a lower take-home pay due to the tax deductions.
- A limited company is a worthwhile option for contractors who want to have more control over their business, as long as you don't mind the added responsibilities of managing IR35, NICs and tax yourself. If you have long-term contracts or multiple clients, a limited company is likely to be more tax-efficient, especially if your contracts are outside of IR35. You'll have the benefit of paying yourself a combination of salary and dividends, and claiming expenses for business related costs. However, running a limited company requires more of you in terms of planning, organisation and financial management, especially when it comes to IR35.
FAQs
What is the difference between an Umbrella Company and a Limited Company?
An umbrella company is a payroll service that handles tax and National Insurance (NI) deductions on behalf of contractors. A limited company (Ltd) is a separate legal entity that allows contractors to manage their finances independently, offering potential tax efficiencies but requiring more administrative responsibilities.
Which is better for contractors: an Umbrella Company or a Limited Company?
It depends on your circumstances:
- Umbrella Company – Suitable for short-term contracts, minimal admin, and contracts inside IR35.
- Limited Company – Preferred for long-term contracting, greater tax efficiency, and contracts outside IR35.
What are the key IR35 considerations when choosing between an Umbrella and a Limited Company?
Inside IR35:
A contractor is effectively an employee for tax purposes. A PAYE umbrella may be a simpler choice.
Outside IR35: A Limited Company provides tax efficiency, allowing you to take dividends and claim business expenses.
How does take-home pay compare between an Umbrella Company and a Limited Company?
- Umbrella Company: Pays income through PAYE, typically retaining 55-65% of earnings after tax and NI.
- Limited Company: If operating outside IR35, take-home pay can be 70-80% due to dividend tax benefits.
Can I move from an Umbrella Company to a Limited Company?
Yes, the transition from an umbrella to a limited company involves:
- Setting up a Ltd company with Companies House.
- Registering for Corporation Tax, VAT, and PAYE if needed.
- Opening a business bank account.
- Ensuring your contracts are IR35 compliant to maximise tax benefits.
How do I compare Limited Company vs Umbrella inside IR35?
If inside IR35, a limited company offers no tax benefits as income is fully taxed via PAYE. An umbrella company may be more practical as it handles tax and admin without the hassle of running a business.
Should I choose a Limited Company or an Umbrella Company for contracting?
- New or short-term contractors often start with an umbrella company.
- Experienced contractors with long-term contracts may prefer a limited company for tax efficiency.
What are the differences between PAYE Umbrella and Limited Company PAYE?
- PAYE Umbrella: Your employer (umbrella company) deducts tax and NI before paying you.
- Ltd PAYE: You control payroll but still need to deduct and report tax obligations.
Can I switch from a Limited Company back to an Umbrella Company?
Yes, if your contracts move inside IR35 or you want to avoid admin, you can close your Ltd company and switch back to an umbrella company.
Which Umbrella Company is best: Parasol vs PayStream?
Both Parasol and PayStream are popular choices, offering full payroll services. Comparing umbrella companies based on fees, compliance, and benefits can help determine the best fit.
What is a Personal Service Company (PSC), and how does it compare to an Umbrella Company?
A PSC (Personal Service Company) is another term for a limited company used by contractors. If inside IR35, a PSC is treated like an umbrella company for tax purposes.
Should I choose a Limited Company or an Umbrella Company if I am a contractor?
If working outside IR35, a limited company is financially beneficial. If inside IR35, an umbrella company is often more convenient.
At Go Limited, we know how confusing IR35 can be for contractors, but we're here to make sure that you get it right. Whether you're working under an umbrella company or you're setting up a limited company, our experts can guide you through working inside and outside of IR35, for both umbrella companies and limited companies.
