ebrief for freelancers and contractors Limited Company, Umbrella or Sole Trader which is the right choice for you?

Transcription

1 ebrief for freelancers and contractors Limited Company, Umbrella or Sole Trader which is the right choice for you?

2 Guide for freelancers and contractors: Limited Company, Umbrella, or Sole Trader which is the right choice for you? Whether you are just thinking about starting your contracting life, or have been contracting for a while, getting the maximum net income for your efforts is likely to be high on your priority list. Whether new or seasoned, to get the best experience of contracting it is a good idea to select one of the popular trading options that suits you better than the others. For some, what may at first appear to be the best option (or simply the easiest) may not be the most suitable or tax efficient in the long run. Navigating through the options may seem daunting but the choice you make can have an impact not only on your employability in certain sectors but also the overall taxation liability you suffer on your earnings. Our guide outlines these options. To help you work out which would suit you the most you will find details on what circumstances each option is generally most appropriate for; the advantages and disadvantages of each; and how they compare to one another in key areas. Our at-a-glance table on page 16 will help you make the right choice. In other words, it can hit you in the pocket. Ideally, it is worth talking your options through with a professional contractor accountant who will be able to advise you on the specifics. However, there are general guidelines, or rules of thumb, to take into consideration which can help you make an informed decision and choose the right trading option for your circumstances. The four most popular options to choose from are: being self-employed (working as a Sole Trader or in a Partnership). working through an agency payroll (temporary) solution. being employed by an Umbrella Provider. setting up your own Limited Company - being your own boss. Contact us If you have any specific questions or just need to chat through your options, you can get in touch with us for a no obligation discussion: Call or enquiries@intouchaccounting.com Visit our website 1

3 First things first: what to consider You have four very different options available in terms of how you choose to provide your contracting services: Being self-employed (working as a Sole Trader or in a Partnership). Working through an agency payroll (temporary) solution. Being employed by an Umbrella Provider. Being your own boss - setting up your own Limited Company. When deciding which option to choose take some time to consider the following factors to make sure you get the best personal (lifestyle), commercial and tax efficient fit: How long you are intending to contract for some trading model options are more suitable if you are going to be contracting for a few months to a year, while others make more sense if contracting is a long-term career. Whether you have previously been employed by the business you wish to contract with - this can affect your ability to claim independent worker status. How many separate contracting assignments you expect to have in the next months - this may affect your ability to claim some expenses against tax. How much you anticipate earning annually some options are more suitable for lower end or higher end incomes, so consider your anticipated annual income. How you envisage working with your clients a consultant may advise many different clients during a year; a contractor may work for only one or two clients on a few bigger jobs; while a freelancer may work for many different clients on lots of smaller jobs. Consider your likely working patterns as this can also affect which option is most suitable. How much commercial risk you will be exposed to some contractor roles carry more commercial risk than others. Consider where your engagements are likely to sit on the risk scale as well as the exact wording regarding liabilities for risk factors in your contracts. How disciplined you are with administration (this includes timesheets and invoicing) only you can know how much administration you are prepared to do, so be honest with yourself! Things can quickly mount up if left undone and may have financial or legal implications if not completed on time. 2

4 Have a go at answering the following questions before reading more about your options as they will either help confirm ideas you already have or provoke more thought. Remember, you can always switch options if your circumstances change and your original choice no longer works for you. YOUR NOTES 1. Are you disciplined enough to work hard at making a success of your career as a contractor? 2. Is there a market for your skill set and experience? 3. Do you know your own strengths and your limitations, so that you do not oversell yourself? 4. Are you flexible and able to adapt quickly to new environments and varying projects? 5. Do you know your market value and is your rate competitive? What are others in your field charging? 6. How are your negotiation skills and will you be able to ensure you get theright rates to keep your business profitable? 7. Do you have a strong network of contacts to keep those referrals coming in? 8. Are you a people person and will you be able to deal with new colleagues and varying levels of demands? 9. How will you make sure you meet your training needs and keep up to date with knowledge and new developments relating to your area of expertise? 10. Are you organised enough to manage your finances and to put funds away in case of a rainy day? 3

5 Your options: most popular ways in which contractors engage with end hirers to provide their services Now we will consider in more detail the different trading models you can select to suit your circumstances: Option: As an agency payroll, or temporary, worker An agency payroll provider (temporary worker agency) acts as the provider of the worker to the end hirer, on often short-term assignments. The agency payroll is responsible for deducting full taxes of PAYE and National Insurance and will pay the worker the after-tax amount. After working at the same hirer for more than 12 weeks the employee will qualify for employment rights. This option is not popular amongst contractors or freelancers as it confers no benefits over and above the Umbrella model (see below) and in most respects follows the rights and obligation for full-time or parttime permanent employment regulations after the initial 12 week period. This option is often associated with short-term, lower paid, seasonal or casual labour. We refer to it here for the purpose of completeness but for career contractors and freelancers it is not a popular choice as the other options all have significantly more advantages. Option: As an employee of an Umbrella company An Umbrella company acts as your employer for work done by you for the client. With this option you will need to complete timesheets, along with any expenses details and submit them to the Umbrella company. They will then issue the client with an invoice on your behalf and pay you a salary based on your timesheets and expenses with deductions made for PAYE, National Insurance and their monthly fee or percentage of earnings. The Umbrella may also deduct from your salary amounts for holiday pay and pension contributions. They will provide you with employment rights and pay over taxes on your behalf. In layman s terms and as simply as possible: Umbrellas facilitate the administration of operating as a contractor by collecting fees from the agency or end hirer, calculating, deducting and paying HMRC your taxes, creating for you an overarching contract of employment (OAC) (which currently has the effect of allowing you to claim tax relief on travelling to and from the client site) and paying to you the balance, after of course deducting a weekly fixed fee, or taking a margin based on your income. Please note: the above comments apply to Umbrella companies who are operating in a compliant way. There are a number of noncompliant Umbrellas whose methods do not meet the requirement to pay the National Minimum Wage, provide their workers with employment protection rights, or properly account for PAYE and National Insurance on expenses. So if you do choose this option, make sure you choose wisely. 4

6 Advantages of using an Umbrella company Short-term option This option can be useful for those who are only planning to contract for a maximum of six to nine months. It is easy to start and easy to stop. Good for dipping your toe into contracting Working with an Umbrella company is often the first option for new contractors as it is quick and easy to set up and can be a good way to test the water in contracting without setting up a Limited Company. As you are effectively an employee of the Umbrella company, your details will not be a public record. Less administration Included in its fee the Umbrella deals with all the paperwork and tax elements on the contractor s behalf so there is also minimal administration involved. Additionally, if you decide to stop contracting, there are no associated costs for doing so. Disadvantages of using an Umbrella company Less take home pay As a general rule you will take home 65-75% of your contracted pay. Compared to a self-employed contractor, or one trading through a Limited Company your take home pay will be lower, because certain expenses may not be allowed for tax, and other benefits (see below) are not available to you. Higher cost This option can work out to be the most expensive tax wise. Although you may make some savings on travel and subsistence compared to an agency worker, you will pay more tax under an Umbrella as your total salary will be liable to income tax and National Insurance in the same way as a full-time employee and you will not be able to take advantage of Flat Rate VAT. For an idea of the difference in take home pay between an Umbrella and a Limited Company set up, try out our Contractor Take Home Pay Calculator: 5

7 Less control Using an Umbrella means you lose the freedom of making your own financial decisions on your earnings as these are all made for you by the Umbrella company. It also means that you are reliant on the Umbrella to collect payment, which could potentially result in delays. Perception Generally using an Umbrella is perceived as an interim solution for newer or short-term contractors. This can be fine if you are only planning to contract temporarily. However, if you are intending to establish yourself in the contracting world for the long-term, particularly if you are working for larger companies and governmental organisations, it is worth considering alternatives. Taxation and employability issues Umbrella companies are increasingly being unfavourably targeted by both the government and industry sector Trade Unions. The Government has recently launched a consultation on Umbrella companies and OACs where intermediary companies provide temporary employees to a number of different clients. The issues raised centre on the fact that Umbrella workers, unlike their regular employee colleagues, can offset their travel and subsistence expenses against income tax. The concern is that some Umbrella companies are reducing salaries sometimes below minimum wage to minimise tax and National Insurance liabilities. The actual salary paid is then made up by exploitative use of non-taxable expenses. This is certainly not the case with all Umbrella companies. Nonetheless, Unions are becoming increasingly frustrated with OACs as some contracts, especially for lower paid workers, amount to an OAC for the purposes of income tax and National Insurance Contributions, but not an employment contract for the purposes of employment rights. This clearly puts these workers at a disadvantage. In response, since January 2015, the Welsh government has banned the use of Umbrella companies on all their future construction projects. Although it is impossible to say exactly how this will pan out in the future, there may be more of this to come. What is certain is that this raises doubts regarding the future employability of contractors using Umbrella companies in some industry sectors. 6

8 Summary Advantages of using an Umbrella company Quick and easy to set up and to leave no costs of forming or dissolving a company. Minimal paperwork and administration. Low commercial risk. Good option for short-term contracts and those intending to contract for no more than six to nine months. Some of the tax benefits of being Limited (on expenses and travel and subsistence costs). Disadvantages of using an Umbrella company Costly as tend to pay more overall tax on income than working through a Limited Company. Tax relief on fewer expenses than for a Sole Trader or Limited Company. Reduced flexibility for management and investment of surplus income. Minimal control must trust the Umbrella to make decisions. Reliance on third party to collect payment could lead to delays. Currently hostile targeting of Umbrella companies by both Government and Unions. 7

9 Option: As a Sole Trader or in Partnership A Sole Trader is a self-employed individual who trades as an individual in their own name or with a trading name that does not include the words Limited at the end! An example would be: David Cameron Services, or David Cameron trading as: Cameron and Co, Ministers and Politicians. Income generated through their contracting business is calculated alongside any other personal income for tax purposes. Sole Traders are more common in some specific industry groups and job roles. Consultants, creatives and journalists tend to be Sole Traders, often called freelancers. Typically they would have a number of clients concurrently either on retainer or for a series of short project-based assignments. Until recently large numbers of workers in the construction sector were self employed under the CIS scheme. Casual workers, seasonal workers and large numbers of workers in the transport and health care sector were also operating in the manner of being self-employed. However, legislation to remove false selfemployment as part of the on-shore intermediaries review has pushed many of these workers into either agency payroll agreements or into Umbrella employment. Unions believe that employers have promoted the shift towards Umbrellas for some lower paid and vulnerable workers in order to reduce their costs and pay below the National Minimum Wage. Partnerships Partnerships are extensions of Sole Traders. More than one consultant will group together, forming a Partnership, to find contracts, share skills and resources. The nature of the business arrangements for sharing costs and profits are normally explained in a Partnership agreement. For taxation purposes each partner will be taxed on their individual share of the income, as set out in the Partnership agreement, as if they were Sole Traders. Advantages of setting up as a Sole Trader or in Partnership Setting up is very easy. Unlike a Limited Company there is no separate legal entity formed so there are very low set up costs - all you need to do is inform HMRC. It offers complete control of finances and has many of the taxation advantages of a Limited Company but without the formality. It also means your contractor income is not publicly viewable. 8

10 Disadvantages of setting up as a Sole Trader or in Partnership Administration Personal risk A Sole Trader has responsibility for all of their trading administration. They must maintain accounting records and produce an income statement at the end of each tax year. They must also collect payments for work done, organise professional indemnity and ensure payment of their tax liabilities. Unlike a Limited Company or an Umbrella worker, the personal and business finances of a Sole Trader are combined. This means that if the contracting business gets into financial trouble, the Sole Trader is personally liable and their private assets could be at risk. Tax efficiency Depending on your income level, you may lose out on a number of tax savings which would be available to you if you were operating using a Limited Company. Perception and employability Anti-avoidance legislation If individuals are genuinely in business on their own account then operating as a Sole Trader can be very efficient. However, for the lower skilled manual workers, and for lower paid workers there is general suspicion that they are not in reality self-employed and they have to demonstrate that they are not under the direction, supervision and control of the hirer. If they cannot do this then they will be taxed as employees. The risk of this is passed on to agencies and end hirers hence the reason for them becoming less popular at lower income and lower skill levels. Many contractor agencies and some companies have a strong preference for Limited Company contractors. This is partly due to the perception of a more established and successful enterprise that being a Limited Company gives. Many agencies will not deal with Sole Traders due to the potential risk of them becoming liable for a Sole Trader s tax liabilities if they are unable to pay them, or more topically the workers being deemed employees under IR35 and other anti-avoidance legislation (for more information on IR35, take a look at our FAQs webpage: resources/faqs 9

11 Summary Advantages of setting up as a Sole Trader or in Partnership Quick, easy and low cost to set up. Complete hands on control of the business. Financials/accounts remain private. Tax efficient if genuinely self-employed. Disadvantages of setting up as a Sole Trader or in Partnership Combined and unlimited personal and business liabilities if things go wrong (unless insured separately). Potentially less tax efficient than operating as a Limited Company. Getting a bank loan is more difficult because Sole Trader bankruptcy is more frequent. 10

12 Option: As a Limited Company These types of companies are also called Personal Service Companies (PSC); Owner Managed Businesses (OMB); small to medium enterprises (SMEs); or one man bands. In essence they are all the same vehicle and the different names create no distinction. Setting up as a contractor Limited Company creates a separate legal entity which can make its own profit and has liability for taxes in its own right. With this set up your business cash and assets are treated as separate from your own personal cash and assets. This gives the contractor a layer of protection if the business gets into financial difficulties because, unlike a Sole Trader, there would usually be no claim on your personal cash and assets to set this right. Constitutionally these Limited Companies generally only have one shareholder and one director (who is the only employee) and invoices are raised in the name of the company to the end hirer for work and services performed by the director. It is not unusual for a contractor trading through a Limited Company to have their partner as a second shareholder and second employee. Depending on other circumstances this can significantly enhance the overall attractiveness of using this type of vehicle. 11

13 Advantages of setting up a Limited Company Tax efficiency Generally, if you are expecting to contract for more than one client for more than nine months and expect to earn more than 25,000 setting up a Limited Company will be the most tax efficient option. Using a favourable balance of salary payments to yourself as an employee (director) and dividend payments as a shareholder (owner) of your business can legitimately help you get the most from your income by maximising tax savings. In addition, there are also legitimate tax efficient ways of organising elements such as payment of VAT, Corporation Tax and Capital Gains Tax. Ideally, work closely with your contractor accountant to ensure you have the most tax efficient financial planning. IR35 To get the maximum tax savings through your company it is essential that your contracting activities are deemed by HMRC as being outside IR35. This means you are treated as genuinely working in business on your own account. This definition is the difference between being taxed as a genuine contractor and being taxed as a disguised employee. If taxed as a disguised employee the income tax and National Insurance Contributions will increase which will reduce your overall tax savings. HMRC assesses each contract individually on its own merits. To avoid doubt regarding your IR35 status it is a good practice to have all your contracts reviewed for IR35 compliance by a professional contractor accountant. Low personal financial risk Setting up as a Limited Company can also potentially benefit those expecting to earn less than 20,000 in some cases, so if this applies check with a professional contractor accountant to ensure you get the best advice and choose the right option for you. A Limited Company is a distinct legal entity so the company s finances are separate from the shareholder s/s personal cash and assets. This means that if, for whatever reason, the company should dissolve, your personal finances are secure. 12

14 Perception Being the director of a Limited Company carries a certain weight in the business community and gives the overall impression of being professional, competent and serious about your contracting career. As being a director of a Limited Company has certain legal responsibilities and obligations, it may raise your overall social standing. The fact that your accounts are available as a public record also means that the financial status of your business is easily verifiable. These factors can open doors for you and help you in securing contracting work. Employability Many agencies and some organisations particularly governmental bodies - will only engage Limited Company contractors. Current Government and Union pressure on the use of Umbrella companies, along with the reluctance of agencies to use Sole Traders, means that the Limited Company option is becoming increasingly attractive. This is why the majority of long-term contractors are now choosing the Limited Company route. Disadvantages of setting up a Limited Company Setting up Forming a Limited Company involves some initial costs and administration, whether you form one from scratch or buy one ready formed. The good news is, incorporating a company from scratch can usually be done in a matter of hours. You will need to make decisions on share ownership (just you, or you and a partner or spouse) and you will also need to appoint directors (including yourself) who will control the business. You will also need to: set up a separate company bank account. register for VAT (if you decide to be VAT registered). set up a payroll mechanism. inform HMRC of your details. Although the onus is on you to set up your Limited Company, a contractor accountant like Intouch Accounting can do a lot of the work for you to make the process as quick and painless as possible (at Intouch, we would take care of all of the above for you within your monthly fixed fee. See: for more details. 13

15 Administration and your responsibilities as director You will be both a shareholder (as owner) and an employee (as director) of your company which means you will have a number of legal responsibilities within your business. You will be ultimately responsible for ensuring the continued success of your business and its operations, keeping accounting records up to date, the preparation of tax returns and filing of information, and ensuring you are aware of and understand your risks under IR35 and other relevant company legislation. If you engage the services of a reputable specialist contractor accountant then they should guide you from the offset to ensure you are fully aware of your obligations and responsibilities. Increase in accountancy costs Due to the complexities of running a Limited Company many contractors choose to engage professional contractor accountants to help them. This may increase their accountancy costs once they become incorporated. However, often the tax savings realised with the advice of a contractor accountant out-weigh the costs as professional fees are tax deductible and, of course, Umbrella companies also charge a fee or percentage for their services. Diminished privacy Limited Companies are required to submit details of their company s activities, including company accounts and information on shareholders. These details will become available to be viewed by anyone as a public record. This can also work in your favour as potential clients can assess your financial credibility before engaging your services. Summary Advantages of setting up a Limited Company Disadvantages of setting up a Limited Company Higher take home pay due to increased opportunities for tax efficiencies. Limited personal liability as company assets are separate from personal assets. Full control of financial decisions and running of the business. Benefit from Flat Rate VAT scheme and more claimable expenses. Outside of Agency Workers Regulations (AWR). Positive connotations of being a Limited Company to potential clients. Increased administration and legal responsibilities for the running of the business. Information on the company including accounts and shareholder information is made public. Not a suitable option for short-term contracts or those intending to contract for less than 12 months in total. Costs involved in dissolving the company, if required. 14

16 Is setting up as a Limited Company the right choice for me? If you are intending to be a career contractor, in it for the long-term, you are most likely to be better off in real terms by forming your own contractor Limited Company. Owning your own Limited Company gives you complete control over your finances and your business, offering all the freedom and lifestyle enhancements that go with this. You get to choose how you organise your tax planning to reap the maximum net income for your efforts and you get to choose how much you need to work to achieve your financial goals. If you are currently operating under an Umbrella or as a Sole Trader and are thinking it is time to make the move to being incorporated, contact us to discuss your options. If you have decided you are ready to set up your own Limited Company we can ease you through the process and provide expert advice. We have in-depth day-to-day experience of setting up contractor Limited Companies and know what works for contractors exactly like you. We can help you get up and running and enjoying the tax savings, freedom and control of owning your own company. It is important you consider all of this information carefully before you make a decision. Our at-a-glance table on the next page helps you summarise your options. 15

17 Your options at-a-glance Umbrella Sole Trader Limited Take home approx % pay Take home approx % pay Non visible accounts Non visible accounts Financial and account information is made public Reliance on third party to collect payment - which may lead to delays Joint control over financial decisions and running of business Full control over financial decisions and running of the business Currently hostile targeting of Umbrella companies by both Government and Unions Getting a bank loan is more difficult due to high levels of bankruptcy amongst Sole Traders Highest level of considered professionalism, and can raise overall social standing and employment success Minimal control, you must trust the Umbrella to make decisions Complete individual/ shared hands on control of the business Complete hands on control of the business Costly as tend to pay more overall tax on income Significantly less tax efficient than operating as a Limited Company Higher rates of take home pay due to increased opportunities for tax efficiencies Some of the tax benefits of being Limited (on expenses and subsistence) Benefits from Fat Rate VAT scheme and more claimable expenses Benefits from Fat Rate VAT scheme and more claimable expenses Good option for contractors intending to to contract no more than 9-12 months Good option for contractors wishing to have similar tax benefits to Limited Companies, but without long term contracts Good option for contractors intending to contract more than nine months as a full time occupation Low commercial risk Combined personal and financial risks, meaning the contractor is personally liable for any financial difficulties Low personal risk as the company s finances are separate to personal finances Minimal paperwork and administration Increased administration and legal responsibilities for the running of the business Increased administration and legal responsibilities for the running of the business Quick and easy to set up and leave - no dissolving or formation costs Quick, easy and low cost to set up Will take some time, administration and initial costs to set up The Umbrella company takes responsibility for liability, therefore the contractor is not liable Shared personal and business liabilities should things go wrong Limited personal liability as company assets are separate from personal assets Monthly fees to Umbrella for administration and account management No fees - although much greater self management of accounts is required Monthly fee to contractor accountant for them to manage the Limited Company s accounts Less administrative responsibilities Director s responsibilities Director s responsibilities Employee of the Umbrella Your own boss / Director Your own boss / Director 16

18 Ready to get started? If setting up a Limited Company sounds like the right option for you, or if you want to talk it through in a bit more detail before you decide, call us on or enquiries@intouchaccounting.com We can help you set up your own company within a matter of hours and get you on your way! I already have a Limited Company - will switching to Intouch save me money? If you already have a Limited Company and are currently working with another accountant, switching to Intouch is easy to do and could save you both time and money. Call us on or enquiries@intouchaccounting.com for more information and an initial chat. If you would like an idea of how much you could be saving with Intouch try out our Cost Comparison Calculator: If you have already set up a Limited Company and are not sure what to do next or if you want to chat through how to get started, call and we can go through your circumstances and advise on what is best for you. Why choose Intouch? The perfect mix of team, technology and expertise for only 92 +VAT per month Intouch Accounting are Limited Company accountants who advise thousands of contractors and help many of them overcome issues with the taxman everyday. We have an experienced friendly team who can set up a company for you, manage your accounts and provide ongoing advice in relation to investing surplus cash. As an Intouch client you will get 24/7 access to our innovative client portal, which saves you time when managing expenses and invoices and lets you know where you stand at all times. Why not explore what becoming a Limited Company contractor means for you? Give us a call on or enquiries@intouchaccounting.com and we can go through your circumstances and advise on what is best for you. We work with contractors every day, helping them to understand their options, make the right decisions for their businesses and save money. We look forward to hearing from you soon. 17

19 ebrief for freelancers and contractors At Intouch Accounting, we work with contractors every day, helping them to understand their options, make the right decisions for their businesses and save money. So speak to us about how we can help you reduce the administration burden. Client Enquiries: New Enquiries: Skype: Intouchaccounting Online: intouchaccounting.com Intouch Accounting Ltd, Everdene House, Deansleigh Road, Bournemouth, BH7 7DU Registered in England & Wales - Company No