For those people who are looking to move in to contracting and out of permanent employment it can seem a daunting prospect. The biggest problem is what is the best way to operate, as a Limited Company or Umbrella Scheme?

For contractors, without a doubt setting up a Limited Company is by far the most tax efficient way to operate. Two of the main tax savings come from paying yourself in dividends rather than taking all your income as a salary. This allows you to save the National Insurance normally paid when receiving a salary. Additionally, should you end up being liable to tax at the higher rate the tax on dividends is only 32.5% whereas on a salary it is 40%.

And utilising the flat rate VAT scheme. This facility allows you to charge VAT as normal on your invoices to customers but you are then allowed to keep some of the VAT for yourself. The amount you are allowed to keep will depend on the type of industry you are working in.

Another benefit is the range of expenses you can claim for via a Limited Company as this is far wider than for regular employees. For example you can claim for equipment, training, software, accountancy fees to name but a few.

With the help of a good accountant the process of working via Limited Company will be straight forward. The only aspect you need to consider is IR35. Should your contract fail IR35 then all of your earnings less a 5% expense deduction will become subject to PAYE.

However despite the ease of setting up and trading via a Limited Company some contractors prefer to steer away from this. So what is the alternative? You can work via an Umbrella Company. In a nutshell these are simply payroll bureaus. Under these schemes all of your pay is subject to PAYE, you may be able to make a claim for travel and meals but the range of expenses you can claim for is extremely limited. Once the Umbrella Company has taken its fee you may find you are actually worse off than if you had simply been an employee of your end client.

If you are choosing to use an Umbrella Company make sure you understand the charges that they will apply. Bear in mind the amount of pay you take home by using an Umbrella Company will be dependent on the amount they charge and nothing else. You may see fanciful claims from some Umbrella Companies claiming to have special dispensations with HMRC exaggerating the expenses you can claim. Beware of the claims being made and check out that what they are saying is correct as such Companies could be operating outside of current tax law.

For advice on setting up a Limited Company please complete the contact form and one of our team will be in touch with you.


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Contractors Tax Advantage is a leading accountancy practice providing accountancy services for contractors across the UK.