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Umbrella vs Limited Company

Becoming part of the flexible workforce (i.e. choosing to no longer be a permanent employee), is a big decision.  The laws governing this space are complex, with numerous financial, tax and legal regulations to adhere to, and there are a large number of service provider organisations that support these workers.  Most people decide to work either through an umbrella firm or through their own limited company.  There are advantages to both, and we have outlined these below.

Umbrella firms take care of the tax implications of contracting, whilst providing you with continuity of employment with all statutory rights, yet also enabling you to fulfil a series of short term assignments.  If you are considering this option, you should also read our section outlining how compliant umbrellas operate.

In contrast, working through your own limited company will generally provide you with higher take-home pay, but in return you will be responsible for all of the legalities involved running your company.  There are many specialist accountants that are able to support you in this process.

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Umbrella Limited Company
You become an employee, allowing you to work on a series of assignments without running your own company. You set up your own company, become a director of the company, and you are responsible for running the company.
Advantages:

  • Ease of set up
  • Centralised tax administration via PAYE
  • All statutory employment benefits
  • Tax deductible travel & subsistence expenses
  • Low risk
Advantages:

  • Total control of your tax and financial affairs
  • Higher take home income
  • Option to legitimately reclaim more business costs than working via an umbrella
  • Flat rate VAT enables you to retain some of the VAT you receive
Disadvantages:

  • Less take home pay
  • Less control compared to your own limited company
Disadvantages:

  • Set up administration – company name, address, directors, articles of association
  • Obtain bank account
  • Sole responsibility for the administration of your business
  • You must show that you are genuinely self-employed and not just a disguised employee.

How a Limited Company Works

Many freelancers choose to operate through their own limited company through which they contract their services to end hirers, enabling skills to be brought in for projects as needed.  This type of set up is often referred to as a personal service company, or PSC.

Limited companies are owned its shareholders and run by its directors, which can be the same individual.  The company is a legal entity with profits and losses belonging to the company, and the company is also liable for its debts.  That means the directors and shareholders are not personally liable, their liability it limited to paying the company what they have agreed to pay for their shares.

The limited company operates by entering into a contract with the firm for whom they are delivering services, and invoicing that firm on a regular basis, usually in arrears.  It is necessary to maintain full financial records, prepare tax returns, file information with Companies House, and understand risks under IR35 and other legislation.  There will need to be appropriate insurances in place to protect the assets of the business.

These responsibilities are more onerous than other ways of working but there are many advantages too, such as: control, greater income potential, limited liability, and professional perception.

Another option is to work as a sole trader, which is a less formal self-employed structure enabling business income to be generated and counted alongside any personal income.  However, this structure has less protection than a limited company because there is no separation between the business and the individual, therefore personal assets are at risk if anything goes wrong.

The legislation and compliance involved in running a company is complicated, so FCSA would always recommend seeking external accountancy and tax advice from a firm with experience in the freelance sector.

How Compliant Umbrellas Work

Umbrella firms employ the freelancer under the terms of an overarching contract of employment.  This requires the umbrella employer to provide full employment rights, and enables workers to undertake a number of temporary assignments, whilst having statutory benefits and continuity of employment.  Additional benefits to the worker include having all their tax affairs managed centrally (rather than being responsible for this themselves with every change in contract) and the continuity of employment history can be helpful if the individual is looking to access financial credit.

Umbrella employers benefit the end-hirer or recruitment business (whichever is applicable) by taking responsibility for all of the employment and tax risk on their behalf.  This enables the contract to be fulfilled by a temporary worker without permanently increasing the hirer’s headcount.

The umbrella will therefore have a contract in place with the agency or hirer and will invoice them the agreed assignment cost for the work carried out.  The umbrella will then pay the worker directly (on a PAYE basis) after retaining monies including their margin, employer tax, employee tax and national insurance contributions.

Offshore structures

Freelancers who are unhappy with the employment structures (such as umbrella companies or limited companies) available to them in the UK will often seek alternate arrangements abroad. Freelancers may choose to use these structures because they offer greater flexibility in the balance between employment rights and the amount of pay they receive. In the simplest sense, freelancers may choose structures that provide little or no employment protections or mandated employment benefits (such as those that will be provided under the Agency Workers Directive). In return, the cost of those protections is not reflected in their pay, allowing them to earn more. The result is that these freelancers, who work in the UK, do not pay tax, leading to a loss in tax revenue for the Exchequer.

The FCSA code of conduct covers both umbrella and limited company accountancy providers, with some members providing just one type of service, some offer both.  Whether you are looking for an umbrella or to set up your own company, by choosing to work with an FCSA member you will have peace of mind that they are fully compliant and working to the highest possible ethical standards.
As an industry-leading body, FCSA work to protect and support contractors and freelancers. Our rigorous code of conduct sets the standard for the service provider sector.

About Myra E.

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