Contractors, Forming a Limited Company or Using an Umbrella Company?


Who says that tax doesn’t have to be taxing? Well obviously the delightful Moira Stuart, who fronts the ad campaign with that dreaded slogan. As the yearly tax return flutters gracefully to the doormat, more than one contractor has no doubt just awoken from the nightmarish dream of Moira in the under stairs cupboard brandishing a monstrous file of invoices and receipts. Tax shouldn’t be taxing, but for many contractors it is. In March this year the Office of Tax Simplification – yes it’s so complex they’ve had to set up a whole expensive wing of government to sort it out – recommended that IR35 legislation be suspended until the tax system read this artile on limited company startups for contractors and small businesses is simplified.

IR35 regulations

For freelancers the decision to operate as sole traders, run their own Limited company or work through an Umbrella company is important, but understanding the relevant tax legislation can make it no easy matter. Limited company formation was popular until IR35 legislation was introduced to combat the rising number of unscrupulous hard-working businessmen and women who tried to maximise their incomes. IR35 was established to help HMRC to identify ‘disguised employees’ working for only one company but using their own Limited company to maximise their income and lessen their tax liabilities. For both contractor and employer there were advantages to the system, and while certainly open to abuse the Limited company structure is one that it is most suitable for many freelancers. Umbrella companies have seen a rise in popularity since the introduction of IR35, but choosing between these structures is not always straightforward.

Benefits of Umbrella companies

Umbrella companies operate by treating the contractor as their ’employee’. The contractor instructs the company who and what to invoice and is then paid through the normal PAYE system by the Umbrella company. This can be a very effective system for contractors – especially those just starting out as freelancers. For those who work solely for one employer – as a contractor – the Umbrella company deals with your tax in a simple way, taking the strain out of hours over the accounts. Anyone who would fall into the IR35 tax rules will benefit from using this simple system – and can ensure that they don’t fall foul of HMRC.

Simpler tax?

With the whole tax system under review – and the future of IR35 legislation anything but clear – the decision for contractors who work for more than one employer or whose work pattern varies, the situation is more complex. It may be possible to establish your own limited company – but if at any stage you fall into effective ’employee’ status you will need to consider how this may affect your tax situation. Whichever route you choose getting professional advice on Limited company formation or the use of Umbrella companies will certainly make sense – and may be more necessary than ever if the government carries out its threats to ‘simplify’ the tax system.



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