Contractors can either choose to be a sole trader where they can combine their trade’s profits with their personal tax return or set up a limited company where they can be a separate legal entity. Often in a limited company, the same individual operates as the worker, shareholder, and director, with the company referred to as a Personal Service Company (PSC).
Numerous contractors opt to use limited companies as it is the most tax-efficient approach, particularly if they are not subject to the harsh IR35 regulations. Conversely, some contractors prefer the hassle-free experience of working through an umbrella company, especially if they are only working for a short period or are caught by IR35.
Advantages in Working Under Limited Company
As flexible working becomes more prevalent, there have been more options on how to balance personal and professional life. For some, the decision of whether to remain an employee or establish their own business looms large. If they choose the latter, they must consider how to structure their new venture, making a clear distinction between self-employment and limited company contracting from a legal and taxation perspective.
However, there is no one-size-fits-all approach. Take a look at the advantages of working as a contractor under this business setup first.
On the Commercial Perspective
Establishing a separate legal entity allows an individual to have their own income and expenditure, enter into contracts, and pay their own taxes. This demonstrates credibility as a supplier, which is crucial when it comes to charging appropriate prices for their services. Instead of being perceived as a temporary worker, you become a business filling a skills gap.
As time goes on, your limited company will gain a track record, credit score, and possibly its own VAT registration, making it even more appealing to potential clients. A trading name under your limited company also enhances your standing when applying for new assignments, while allowing flexibility to undertake ad-hoc work for other vendors if desired.
If you have other business interests, having a limited company can also present a professional image of your enterprise, further emphasizing your credibility and commercial advantages.
On the Personal Perspective
By separating the trade from yourself, your personal assets are protected from potential claims from suppliers, customers, and employees, as long as the company has been run properly. Your personal liability as a director is limited if things go wrong, except when personally guaranteeing a bank loan to the company.
On the other hand, an unincorporated sole-trader faces many financial risks jointly with the individual, as they are not separated from the trade like in a company. This level of control and protection makes forming a limited company a smart choice for both business and personal reasons.
As a director of your own company, you have complete control over all transactions and revenue, including invoicing. You can also decide on the best way to remunerate yourself, choosing the optimum split between salary and dividends, and when to draw income from the company. Limited company owners can easily sell or pass on the company to future generations.
There are also psychological benefits to running your own business. Being in charge of your calendar, location, and working practices gives you personal freedom. Setting up and maintaining a company reinforces the separation between work and life, even without physical barriers, making it easier to keep them separate.
On the Tax Perspective
Contracting via a limited company is more tax efficient than working via an umbrella company or being an employee. Limited company contractors typically take a small salary, minimizing PAYE and NIC liabilities, and withdraw the remainder of their income in the form of dividends, which are not subject to NICs.
An unincorporated sole trader is taxed on all profits made in a period. However, a limited company pays corporation tax on all profits made similarly, but the individual contractor only pays income tax on the income taken from the company in a tax year.
You can also potentially split company shares with your partner to take advantage of personal tax allowances and base rate bands. And while the benefits of incorporation are reduced if caught by IR35, you may still benefit from joining the flat rate VAT scheme and using the 5% expenses allowance, depending on your eligibility.
Expenses are not taxed, and you can claim for a wider range compared to those inside IR35 or those on PAYE, provided you are outside IR35 legislation. These include company formation and accountancy fees, travel and accommodation, phone calls, postage, office equipment, insurance, business entertainment, and National Insurance and pension contributions.
Working as a limited company also allows for the offsetting of expenses, which increases with a corporate structure compared to working as an employee who now have to deal with CJRS issues. This allows for strategic planning of when to take amounts from the business to maximize the benefits of various tax bands and allowances.
If you sell your company and have accumulated funds, you may be able to benefit from the Entrepreneurs’ Relief scheme, which allows you to pay only 10% in CGT on share sale proceeds if you have owned the shares for a year or more.
Disadvantages in Working Under Limited Company
Incorporating a limited company requires significant administrative work, including paperwork and opening a business bank account. You must remain organised to meet HMRC and Companies House deadlines and avoid costly penalties. IR35 legislation may also impact the amount of tax and National Insurance you pay, while also restricting your ability to claim expenses.
Annual accountancy fees and professional liability insurance costs are also necessary expenses for limited companies. Running a limited company outside of your country of registration may be complicated too, and the additional administration required may not be suitable for those seeking short-term contracts.
If you’re planning to set up a limited company and work under it as a contractor, seek the help of business and tax experts. Legend Financial is here to help you all the way. Reach us today!