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Many contractors work through limited businesses since it is the most tax-efficient way to do business, especially if you are not subject to the IR35 regulations.

Others who don’t want to deal with paperwork, are contracting for a short length of time, or are subject to IR35 may prefer to contract through an umbrella business because it is a “hassle-free” option.

So, what are the benefits and drawbacks of forming a corporation?

Benefits of Limited Liability Companies

Working as a contractor for a limited company is more tax effective than working as a contractor for an umbrella company. Limited business contractors generally take a minimal wage (to reduce PAYE and NIC obligations) and withdraw the rest of their earnings as dividends. On corporate dividends, no NICs are due.

If you are subject to IR35, the benefits of incorporation are much diminished, although you may still be able to profit from the flat rate VAT scheme and the 5% costs allowance. You’ll need to check with your accountant to see if you’re eligible.

If you have other business interests and want to project a ‘professional’ image for your company, having a company will be beneficial.

If something goes wrong, your personal culpability as a director is restricted, as the name implies. One exception is if the corporation asks you to personally guarantee a bank loan.

As a director, you have complete responsibility over the company’s financial and administrative issues.

You can divide ownership among a number of people by creating multiple share classes, which can be handy for tax planning, attracting investors (if you diversify your firm), or dividing ownership among a lot of people.

Owners of limited companies have more control over their remuneration. You can decide on the best pay and dividend split, as well as when to take money from the corporation.

A limited business can be easily sold or handed on to future generations because it is a legal entity in its own right.

If you sell your firm and have accumulated capital within it (which is rare for the normal contractor), you may be eligible for the Entrepreneurs’ Relief scheme, which allows you to pay only 10% CGT on share sale proceeds if you have owned the shares for a year or longer.

Limited companies have a number of drawbacks.

Working through an umbrella company requires less administration than running a business (although typically your accountant will take most of this burden away from you).

Company filing fees, accountancy fees, stationery, and one-time legal and administration expenditures are some of the costs connected with starting a business.

Your business must file Annual Accounts with HMRC and Companies House each year, as well as a Confirmation Statement (formerly known as the ‘Annual Return’).

Even if your accountant does these tasks, as a company director, you are ultimately responsible for ensuring that your accounts are completed appropriately and presented on time.

If you provide contract services through a ‘intermediary’ (your limited business), the IR35 legislation may apply to relevant assignments if you have not taken the necessary steps to ensure compliance. Being caught up in IR35 has serious financial ramifications.

Someone wanting to take on a short-term contract may not want to go the limited company way.

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