Umbrella Vs Limited Company – the true 2021 picture

The good old “Umbrella Vs Limited Company” debate has always raged on the contractor agenda, but with changes to IR35 just around the corner, this year it’s set against a very different landscape.

When someone decides to work as a contractor or freelancer, one of the things they need to decide is how they are going to structure their engagement and pay themselves. Two common ways to do this is to set up a limited company (also known as a Personal Service Company or PSC) or to work via an umbrella company.

Let’s start with some basic definitions:

What is a limited company?

A limited company is a type of business structure which is its own legal entity, separate to its directors and shareholders. 

When a contractor provides their services through a limited company, they extract money from the company in a combination of salary and dividends from the company’s available profits.

Traditionally this is the route of choice for contractors genuinely in business in their own right; setting up and running a limited company comes with full control and autonomy but also financial risk. It also involves certain obligations and responsibilities to statutory bodies, including HMRC and Companies House. 

Do IR35 rules apply? – Yes

What is an umbrella company?

An umbrella company acts as an intermediary between a contractor and their agency or end client. 

They are employed by the umbrella company with all PAYE tax, NI and pension contributions deducted directly from their income, and entitled to statutory employment benefits like sick pay and holiday pay.

Umbrella companies have always been seen as a good choice for first-time contractors, and indeed for those operating inside IR35 – hold on to that thought, because now it is more crucial than ever. 

Do IR35 rules apply? – No

A (very) brief history of IR35

We know IR35 has been around a long time (over 20 years in fact), but there is a major sea change coming. 

Here’s a very quick rundown on the background to the IR35 off payroll reforms, up to where we are now:

The crux of IR35 is if a contractor is doing the same work, in the same place, in the same way as an employee, they should be taxed as an employee. 

From April 2017, for those contracting in the public sector, responsibility for determining whether a contract fell within IR35 moved away from the limited company director to the end client engaging them. 

The government’s plan was to test this out in the public sector before rolling it out to the private sector. Then Covid came along and the plans were shelved for a year, and will now come into effect from 6th April 2021. This is already enshrined in the 2020 Finance Act, so there is no going back.

Contracting in a post-IR35 reform world

The shift in responsibility and determination of IR35 will make things more black and white, but it will inevitably mean that some people currently contracting through limited companies will no longer be able to do so. Even if they are, it may not be financially viable. 

No PSCs here please

Many private sector hirers are simply deciding not to engage limited company contractors after 6th April. 

This is not classed as a “blanket decision” on IR35 status, but a commercial decision, which is entirely within their rights to make as a business. 

For many contractors this will take the choice of limited company working off the table completely if they want to take the job. 

Contracts inside IR35

If the end client determines that a contract falls inside IR35, the contractor in question can still get paid through their limited company. They get paid a so-called “deemed payment” where “deemed employment” deductions equivalent to PAYE are taken off their gross income.

Added to this the cost of retaining an accountant (even during periods of no work) and other considerations such as insurances, means that working through a limited company very much loses its financial lustre.

Take home pay – deemed payment Vs umbrella

Click here for a full breakdown of this calculation.

Umbrella companies – the facts

There has been a lot of shade cast on umbrella companies on various forums and social media, so we’ll stick to the facts (so long as the umbrella company in question is doing things right):

  • The “umbrella rate” or “charge-out rate” paid by the agency to the umbrella includes all employment costs, including Employers NI and holiday pay. The worker does not pay these costs out of their wages.
  • Contractors get full statutory employment rights
  • Contractors are covered by the umbrella’s insurances
  • All the umbrella company takes is their margin, which is a simple processing deduction.

Umbrella Vs limited company – at a glance

Limited company

Umbrella

Status You are the director of your own company You are an employee of the umbrella company
Set up Company formation and registration with a specialist accountant takes a few hours. Registration for tax and VAT takes a few weeks Instant set up
Legal duties Various statutory and financial obligations No legal duties
Control You have a high degree of control over your business Little control
Ease of use Monthly admin to compile accounts Minimal admin
IR35 Applicable – after April 2021 end client decides IR35 status Not applicable
Pay and taxation Outside IR35 – combination of salary and dividends

Inside IR35 – “deemed payment” equivalent to PAYE

Salary is taxed via PAYE
Insurance Your company needs to pay for business insurances inc. Professional Indemnity Insurance cover is typically included in the umbrella company’s margin
Self assessment All company directors must complete an annual self assessment tax return No need to complete a tax return unless you earn untaxed income on top of your umbrella earnings

Main takeaways

We hope we have provided some clarity into how contracting options will look after April. 

For assignments outside IR35, the Umbrella Vs Limited discussion goes very much as it did before, with contractors weighing up their decision based on financial risk and reward, control and liability. 

However for contracts inside IR35, or where PSC contracting is just not an option, umbrella companies offer stability and financial parity – just be sure to do your homework when choosing one.