If you're looking to become a contractor, then you need to consider the two main options open to you – operating as a limited company or using an umbrella company. However, you must be aware that this decision is dependant on whether or not you are truly self-employed.
This is a piece of legislation that was introduced by HM Revenue and Customs (HMRC), when the taxman was looking into the number of instances whereby salaried employees were operating as limited companies in an effort to reduce the amount of tax they have to pay.
Before you consider setting up as a limited company, you must determine if IR35 applies to you because if HMRC were to consider you to be an employee you will be liable to pay the same tax and national insurance contributions as a salaried member of staff would.
However, HMRC's definition of self-employed is far from clear-cut and it can therefore be difficult to know whether you fall inside or outside of the regulations.
It is generally thought that you will be considered to be an employee if a client dictates your working hours and the way in which you complete the project. If this is the case, you must adhere to the regulation and will not be able to operate as a limited company contractor. In these cases, using an umbrella company would be the best option.
On the other hand, if you are in control of how, when and where you work, you are likely to be considered by HMRC to be operating outside of the legislation and will be free to establish yourself as a limited company contractor.
If you are outside of the IR35 legislation, then working as a limited company can reduce your tax burden, as it is a more tax efficient way of working.
You will also have complete control over all business transactions and matters relating to the company because you are the director. By operating as a limited company contractor, you will be able to choose a trading name and develop a brand that you can represent. This can make all the difference when it comes to impressing potential clients and securing lucrative contracts.
Because all funds are paid into accounts you are controlling, delays are minimised and such processes are much quicker.
On the other hand, it is important to be aware of the significant amount of admin and paperwork involved in becoming a limited company contractor and that's not to mention the burden of being responsible for your own day-to-day filing and invoicing.
HMRC will levy penalties if you are late or cannot provide paperwork they request and it is often necessary to keep copies of relevant documents for up to five years. However, it is possible to engage the services of an accountancy services provider who will assist you in meeting your statutory obligations.
More and more contractors are looking to utilise the services of umbrella companies, especially those just starting out. These organisations take care of the administrative burden, meaning all the contractor needs to do is submit a timesheet and relax, safe in the knowledge everything else will be sorted for them.
There is no need for umbrella contractors to keep spreadsheets or VAT returns, or worry about new payroll regulations – such as the recently implemented RTI.
All tax and national insurance deductions will also be made on their behalf.
Furthermore, those choosing to operate in this way are effectively seen as employees of the umbrella company. This means they have access to state benefits such as maternity pay and a pension.
If you are confident that you will fall outside of the IR35 regulations and would like to minimise your tax burden, then you should be looking to operate as a limited company contractor. But how do you go about setting up a limited company?
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