When initially setting up as a contractor you face a choice. Will you operate through an umbrella company or as a director of your own limited company? Many opt for the latter due to the potential benefits.

Changes to Travel & Subsistence tax relief legislation means contractors with umbrella companies have seen substantial drops in take home pay from April 2016. Many are reviewing their choice once again, as a result. Could now be the time for you to make the transition to contracting via a limited company?

In this guide, we cover:

  • The benefits of contracting through a limited company
  • A note of any caveats to be aware of
  • How to go about making the transition

Benefits of contracting through a limited company

The change to Travel & Subsistence relief rules affects claimable tax relief for movement between home and work. The modification applies to all workers supplied through intermediaries such as umbrella companies. Any contractors caught by IR35 – in other words, not meeting HMRC’s definition of “self-employed” – will also feel the effects.

If you are currently a contractor working for an umbrella company, do you see the ability to claim this tax relief as an attraction? If so, now might be a good time to re-evaluate the various other advantages available to limited companies.

  • Tax efficiency: Contracting via a limited company is the most tax-efficient method available. It allows you to claim for a greater range of expenses, and grants access to a flat rate VAT scheme allowing you to keep a sum of the total paid.
     
  • Greater control: A limited company also has greater influence over its finances. As director you may arrange for direct collection of payments – rather than relying on the umbrella company. You also get the last word in development and expansion efforts.
     
  • Extra protections: In the event of catastrophe, limited company directors are not considered liable for losses by the business. In addition, registering through Companies House reserves your company’s name. This prevents others from using that name through Companies House, so long as you are on the books.
     
  • Appearances: Being a limited company can entail other interesting status benefits. Many clients, for instance, view firms with a ‘Ltd.’ in their name as more professional, leading to more business in some cases.

As you can see, there are plenty of worthy reasons to begin planning the change. Soon, we’ll tell you how. There are a few things to consider first:

Limited companies - some caveats

If you previously opted for contracting through an umbrella company, you’re probably already aware this path isn’t for everybody. The running of a company is an entirely different thing from being an employee in somebody else’s organisation. Ultimately, the responsibility falls on your shoulders to ensure everything remains on the books and in full compliance with HMRC. You may require a certain constitution to handle this responsibility.

Furthermore, your obligations are bound to increase upon setting up of your limited company. The best way is to find and hire a contractor accountant to assist in the new business-running duties.  It is workable to manage your accounts yourself, but it is not always advisable.

The accountancy services on offer that you’re looking for are:

  • Completion of forms on your behalf (P11D, P35, P60, etc.)
  • Provision of tax planning advice
  • Preparation of year-end accounts
  • Completion of VAT returns

You should be sure to check which of these services your accountant’s fee structure covers. Having some help in this department really can make the difference in the smooth operation of your business.

It’s worth noting some contractors avoid making the change to a limited company because of a perceived reduction in privacy. The filing of your records and accounts with Companies House means anyone can access or read them. If for some reason you consider this to be a problem, you may want to hold back.

How to transition from an umbrella company to a limited company

So you’ve decided to make the move. Thankfully, the transition should be pain-free. Certainly it is no harder than the process of moving from PAYE employment into contractor work.

1: Choose the time & inform the necessary parties

If you have a notice period to see out under your contract, you will need to give the appropriate amount of time to allow for the transition. If not, simply inform your umbrella organisation of your decision. You may receive a P45 form, but having one is in no way a requirement for setup of your company.

If you are currently in the middle of a contract, you may want to wait for a gap before the next renewal. Otherwise, your present contract – signed between the umbrella company and the client – will need review and alteration. Furthermore, any such adjustment would need to be signed off by both the umbrella company and the client.

Be sure to check the terms and conditions of your contract to ensure you won’t incur penalties before engaging in this step. It’s always good practice to chase, at this stage, any outstanding payments owed to you by the umbrella company as well.

2: Set up the limited company

The process of setting up your company is a simple affair, achievable with only some hours’ time investment when you hire an accountant. If you can find a specialist contractor accountant to handle the setup, even better.

You will need:

  • To designate yourself in the paperwork as both director and employee of the limited company
  • A business bank account to handle payment. To be kept distinct from your personal finances, as your company will become its own legal entity.
  • The correct contractor insurance, to protect you against any claims brought against you by clients. In many cases, both professional indemnity insurance and IR35 insurance are seen to be requirements for responsible contracting.

In summary

The costs of using an umbrella company for contracting purposes are higher than those associated with limited companies. April’s legislative changes have only exacerbated the gap between the models, affecting many entrepreneurs for the worse.

If that isn’t the deal breaker for you, then the numerous advantages available to limited companies – from tax planning opportunities to reduced liability – ought to get you thinking.