What is an Umbrella Company?
An umbrella company is quite simply a large limited company which operates as a kind of agency on behalf of contractors from various industries. In most situations, a contractor will be a self employed person who will do short or long terms periods of work for various companies, rather than remaining in the employ of a specific company. There are however situations where organisations are opposed to taking on such self-employed contractors and require invoices to be issued via a limited company. This is where umbrella companies come in. Umbrella companies offer self employed contractors the ability to carry out work for their chosen organisation and the umbrella company will simply invoice that organisation on behalf of the contractor. In the past this was seen as a simple solution to the problem. However there are problems with using an umbrella company.
The Disadvantages of Umbrella Companies
Although using an umbrella company might seem like a hassle-free method for a contractor to carry out work for an organisation there are a number of downsides. Firstly and probably most importantly is the financial matters. Most umbrella companies act in an agency style, imposing charges or service fees on the contractor. They may take a percentage of the money earned by the contractor through his work with the organisation. Therefore meaning that the contractor will end up taking home less money than he or she would otherwise have earnt.
The umbrella company also dictates how the invoices are dealt with. Generally speaking this means that the umbrella company will use a PAYE system to pay the contractor, treating them as a temporary employee of the company. So as well as being subject to the commission charges levied by the umbrella company, the contractor will also be subject to Tax and NI contributions.
What Is The Alternative?
The alternative to using an umbrella company is to set up a limited company. Many people will be put off by this option, thinking there is a lot of hassle involved and some umbrella companies would have you believe that the long terms costs make it prohibitive. However, there are a number advantages of a limited company which make this option far more appealing.
Advantages of a Limited Company
Most notably, using a limited company means that a contractor can take advantage of the tax advantages offered to such an entity, he or she will retain full control of how they invoice the organisation(s) they choose to work for and how they go about paying themselves. Due to the nature of the tax laws surrounding running a limited company, it is possible to do this in a far more tax efficient way. Paying via dividends allows a director to counter the higher rates of tax levied on personal income tax.
There are several other advantages which allow the contractor with a limited company to be tax efficient and thus maximise their take home money from contracting work. Clearly this includes the ability to reclaim tax on company expenses among other things.
The cost of setting up and running a limited company is not as much as people think (or umbrella companies would have you believe) and if, as a contractor, you intend to work for a number of clients over a variety of periods of time then this means that the cost will be spread over that time. If you consider that the commission charges will mean that a contractor may only take home 60% of their earnings then setting up a limited company is far more appealing.
Cost Efficient Company Formation
If you are a contractor or thinking of undertaking contracting work, then why not take advantage of our low cost company formation service. For a limited time you can set up a limited company for free and with legal and tax advice available from our business consultants and our recommended accountants – Pinnacle Accountancy, you can be sure that your own limited company will be far more tax and money efficient than using an umbrella company.