There are several ways to structure a business and finding the right approach is critical not only for growth and success but also how you manage your finances including tax affairs.
A limited company is a separate legal entity through which the running of the business is conducted. All liability for losses and debts incurred lies with the limited company rather than the owner or owners.
An umbrella company employs temporary workers or agency contractors and can be a good option, for example, if you don’t want the administrative challenges that come from running a limited company.
There are tight rules when it comes to whether you can run an umbrella company, however, choosing this as an option for your business will depend on a range of different considerations.
For example, you can only be employed on short-term contracts if you want to maintain independence. It is more suited to industries such as construction, for example, where individual building contractors are hired on-demand to complete particular parts of a development or project.
Here we look at the similarities and differences between umbrella company vs limited company models and which is best suited to your business structure.
What is a limited company?
A limited company is created when a business is registered with Companies House as such and thus becomes a separate legal entity.
It means the owner or owners and shareholders of the business are not liable for losses and debts as individuals – their personal assets and income are protected and limited to the amount of their investment in the company itself.
To run a limited company, the business needs to pay a range of different taxes including VAT and corporation tax. They are also responsible for processing the income tax and National Insurance contributions for employees, including directors.
Pros of a limited company
- The single biggest benefit is limited liability, which means if the company goes bust or has financial difficulties the assets of owners and shareholders are seen as separate and cannot be touched.
- The professional status of a limited liability set-up can be more appealing for other businesses looking to contract services, increasing the opportunity to build growth and sustainability through a better reputation.
- Compared to a sole trader or no LLC status, a limited company can take advantage of better tax efficiency and planning. For individual owners, the personal tax liability can be reduced by a combination of salary payments and dividends.
Cons of a limited company
- One of the biggest disadvantages for businesses is that the paperwork for a limited company is more complicated. It needs to file or register with Companies House and follow certain rules and regulations.
- LLCs must submit accounts to Companies House and be more open and transparent about their operation.
- There are also strict procedures when taking money out of the business and how the limited company is organised.
What is an Umbrella company?
An umbrella company employs people on short-term contracts for other clients rather than having full-time employees. This is often a factor in construction companies where individuals are hired because of the skills to fulfil certain jobs for the end client – for example, bricklayers, roofers in construction or graphic designers and IT specialists in the digital professions.
For sole traders and self-employed contractors, this presents a number of advantages because all the paperwork such as paying taxes and holiday pay is handled by the umbrella. You are essentially seen as an employee of the umbrella company for the duration that you are working for them.
Pros of an umbrella company
If you are a contractor, working through an umbrella company ensures that you have access to clients and work that you might not otherwise be able to get. There is less paperwork hassle compared to those faced by limited company contractors.
You don’t have to worry about completing a self-assessment or doing the books as all your tax deductions and national insurance and holiday pay are handled by the umbrella company.
Cons of an umbrella company
You tend to pay fees on top of your tax and national insurance that can add to the cost of your operation.
Working through an umbrella company vs a limited company used to have tax-efficient benefits in that you could still class yourself as a self-employed contractor or say you have your own company. With amendments to employment legislation and the IR35 rules, however, this changed in 2021.
IR35 was essentially brought in to stop contractors who are classed as self-employed or have formed their own limited company from working as an employee. This covers contractors who obtain their work through umbrella companies and PAYE agencies.
In short, if you work through an umbrella company you are considered an employee and not a company in your own right or self-employed.
Frequently Asked Questions about limited companies and umbrella companies
What is the difference between a limited company and an umbrella company?
The main difference between a limited company and an umbrella company is the way you pay your tax and whether you are seen as an employee or not. In an umbrella company, your tax and NI is taken out of your pay or fee for the job you do. The company essentially acts as an intermediary but it is also an employer.
Limited company contractors have a much wider scope and the business is seen as an entity on its own with responsibility for producing accounts, payroll and paying things like corporation tax.
Which type of company formation is better for me?
A lot depends on the industry you work in and the type of revenue and growth you expect. Limited company statutory and financial obligations are more complex but they deliver various tax benefits. Umbrella companies are more often suited to smaller sole traders with lower incomes who don’t want the hassle of doing their own books.
Do you pay more tax with an umbrella company?
You pay the same tax as someone working for a business but you can also access things like sick pay, pension contributions and the like. You will also likely need to pay some sort of fee to your umbrella company.
Can my limited company be my umbrella company?
You can have a limited company and operate as an umbrella company and many businesses do follow this model. The contractors that you take on for a client are seen as employees and you will need to manage their payments and tax.
Is PAYE or umbrella better?
Since the IR35 rules came in, there’s probably less difference between PAYE agency and umbrella. Most will cover your tax and elements like holiday pay and the reputable companies will even ensure you are covered by insurance. An umbrella company may give you more opportunities to claim additional expenses.
Whether to choose a limited or umbrella company will depend largely on your circumstances and which is the most tax-efficient way while still providing you with a solid income.