If you’ve recently started contracting, either by choice or through circumstance, you may have been advised to set up your own limited company in order to get paid. But this is no light decision as you need to take on a certain amount of financial and legal responsibility.
So what are the benefits and when is the right time to take the plunge?
You get to take home more pay
It’s widely known that contractors who get paid via their own limited company tend to take home a higher percentage of their invoice or contract rate. In other words, it’s a highly tax efficient way to get paid when compared to being paid via PAYE by your client or recruitment agency or by an umbrella company.
Depending on your circumstances, you could take home as much as 85% of your contract value but more typically, the figure is around 75%. If you’re in permanent employment, take a look at your last payslip to see just how much more attractive that percentage is!
The things that will affect the figure are whether you are a higher rate tax payer, the amount of business expenses you can legitimately claim, whether you can have a second shareholder (usually a partner or spouse) who is a lower rate tax payer and who is actively involved in the running of the business and how you structure your company. Most contractors take a small salary and the rest of the money as a dividend, which is not subject to National Insurance contributions, thus making it more tax efficient. Don’t forget that limited companies do have to pay corporation tax though. In order to make contracting a viable choice, there are also tax breaks on things like training, pension contributions, childcare vouchers and insurances.
Credibility and control
Of course, not everyone is motivated by money and there are other benefits to running your own limited company:
- Clients often tell us that they prefer limited company contractors as it tells them that the person is credible and committed. Indeed, HMRC actively discourages agencies from working with sole traders.
- You will have more control over the terms of your employment, for instance how many days holiday you decide to take (within reason if you’re mid contract of course) or the number of hours you will work.
- We defy you not to feel a little bit of pride when you tell people that you run your own company.
- It starts to shape your plans for the future. Could you end up growing your business, taking people on or handing something valuable on to your children?
There must be some downsides?
Given the benefits, you’d assume that all contractors would run their own limited company. So why do 12% of the contracting workforce use an umbrella company and still more let their client pay them directly or sometimes become self employed?
Limited company only really works if you’ve decided to commit to the contracting lifestyle for at least 12 months. This is because the costs involved in setting up your company and submitting your annual accounts aren’t justified if you only trade for 6 months. So if you are treating this as a stopgap between permanent jobs, an umbrella company might be a better bet.
It is true that as a limited company director, you become responsible for a certain amount of paperwork such as submitting annual accounts to Companies House, corporation tax returns, VAT returns if you are registered for VAT and paying any income tax and National Insurance liabilities you have. However, most contractors we speak to at KDR say that over time, they work out efficient systems for their financial record keeping and let their accountant take most of the strain. This means that they may only spend 2 or 3 hours per month on their accounts which doesn’t sound too onerous to us.
IR35 is a dreaded word in the contracting industry but it generates more fear than it deserves in our view. IR35 is a piece of legislation introduced in 2000 that was intended to stop what the Government viewed as ‘disguised employment’ ie the practice of a person leaving full time employment and starting back again the following Monday as a contractor doing exactly the same job but with additional tax incentives. The legislation doesn’t stop you from doing this, but you just won’t be able to benefit from the same tax advantages. Investigations, fines and litigation around IR35 are relatively rare but no-one wants to be the exception that proves the rule. If you suspect that your contract could fall foul of IR35, seek specialist tax advice. Contractors employed by umbrella companies don’t fall within the remit of IR35 so they offer a compliant solution.
- Expensive to run?
You might feel that you don’t want to incur any costs when it comes to getting yourself paid. In that case, running a limited company might not work for you as you will have to pay to form and incorporate your company, and unless you are pretty financially savvy, pay for the services of an accountant. However, accountancy fees can be offset against tax and because it’s such a competitive industry, can be very reasonable depending on the level of service you want. Your choices are to invest in a DIY online service, use your local high street accountant or appoint a specialist contractor accountant. You can expect to pay between £60 per month at the cheapest end to £180 per month to have everything taken off your hands.
So if you’re thinking about starting contracting or are at the point where it’s going to become a long term career choice, we hope that this article has shown you the benefits of setting up a limited company and been fair about pointing out the drawbacks
There are lots of useful calculators out there which will show you just how much better off you could be financially (we like this one particularly) but if you want to ask any questions, please fire away below.