This is where you ‘ the contractor’ essentially become an employee of the umbrella company. You submit time-sheets to the umbrella who will in turn, invoice the end client (or agency) for the work done by you. You will then be paid as a PAYE employee less the umbrella fee.
You will usually be allowed to claim some basic expenses, however be cautious of umbrella companies advertising ‘special’ dispensations or expense policies ‘approved by’ the Inland Revenue, that claim to allow expense claims without the need to produce receipts. The Inland Revenue have made it clear that they intend to challenge any company considered to be actively encouraging tax avoidance through fraudulent expense claims.
You’ll typically take home around 60% – 65% of your contract by working through an umbrella company.
It is very important to stress that these must be genuine, one person limited companies and not a ‘scheme’ dreamed up by what are nothing more than marketing organisations.
The first things you, the contractor will need to do is form a limited company and open a business bank account (your accountant will help you with this). The director controls invoicing, the company bank account and decides on how much to pay themselves, which is made up of a combination of salary and dividends.
The limited company’s contract can either be with the end client or the agency and the company can claim as tax free expenses: travel and subsistence, hardware and software, training, professional subscriptions, business telephone, accountancy fees plus any other business costs.
You may also like to read our Guide to Contractor Expenses, new page about ‘How much can I earn as a contractor’ and take home pay case studies of a contractor using an umbrella company and another who’s working through their own limited company.
You’ll typically take home around 75% – 80% of your contract by working through your own limited company.
Below, we’ve summarised the pros and cons of each method, for a more detailed review click here for our full first-timer guide and here for our step-by-step guide to contracting.
Limited Company v’s PAYE Umbrella
|The most tax efficient way of working.||Very easy to use, you simply enter your timesheet and expense details and wait to be paid.|
|Claim a wider range of expenses||All tax and NI is deducted before you receive your money, so you will have no further taxes to pay.|
|Access to the Flat Rate VAT scheme.||Ideal for short term contracts.|
|You keep complete control of your financial affairs meaning you do not have to risk your money with any third party administrator.||Ideal for contracts less than £25k per year.|
|Running your own business isn’t difficult; submit spreadsheets to your accountant – just like umbrella time-sheets and expenses.||Good if you are unsure if contracting is for you and you’re really just in between permanent jobs.|
|Greater opportunity for tax planning than PAYE Umbrella||Someone else will be doing all the paperwork.|
|There is a certain amount of paperwork involved, usually about 10 – 15 minutes per month.||The most expensive way of working. You will receive a salary that is subject to full PAYE Tax and NI, it’s just like being a permanent member of staff again.|
|Can be costly if you contract for a very short period of time, then go back to permanent employment.||You are reliant on the umbrella company to collect your money from the client or agent and then to pay it on to you.|
|Not ideal for contracts less than £25k per year.|