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Contracting: Choosing an operating structure

Earlier this week we launched a new series of articles on making the switch from permanent to contract work.

So, if contracting has got you intrigued, what are the practical steps you need to take to make it happen?

We’re going to take a look at three key elements you need to get your new contracting lifestyle off the ground – your operating structure, your finances, and the actual process of finding contract work.

Today is all about operating structure.

Realistically, there are two options open to you. You can set up your own limited company, or you can work through an umbrella company. (Most businesses will not work with contractors operating as sole traders, and while some recruitment agencies offer pas-as-you-earn (PAYE), we don’t recommend this; it’s much less flexible and is also the least tax-beneficial choice).

So, an umbrella company or your own limited company?

Contract through an umbrella company and you become their employee. They hold a B2B contract with the organisation you contract with, and they’re responsible for paying your tax, national insurance and organising elements like tax-deductible expenses. An umbrella company’s role is to make contracting as tax-efficient as possible for you, and in return they take a fee, normally as a monthly payment (this is not tied to your day rate).

It’s efficient and easy, and relieves you of any complex legal or financial responsibilities.

Set up your own limited company, and you become a company director. There’s no monthly fee involved, but that’s because you’re taking on the legal responsibilities yourself. You must submit an Annual Return to Companies House, register for VAT and pay it quarterly if you earn more than £60,000, pay corporation tax on all your profits and (probably) appoint an accountant to produce your year-end accounts. If you default on any of these elements then you are personally liable.

On the other hand, you can dictate how you pay yourself, through a combination of salary and dividends, and purchases like a car or laptop can be tax-deductible as company expenses. Historically, setting up a limited company has been the most tax-efficient way for medium to high-earning contractors to work.

However, the government made significant changes to the tax system for limited companies in the 2015 summer Budget. From April 2016, company directors have a tax-free dividend allowance of £5,000, and beyond this, marginal bands of dividends are taxable at 7.5%, 32.5% and 38.1%. Setting up a limited company is still probably be the most tax-efficient way for you to work if you are a medium to high earner, but the advantages it holds over other structures have reduced.

Which operating structure is right for you? It really depends on what matters to you. If you want to contract with the minimum of fuss and don’t mind paying a bit extra for someone else to handle the complicated stuff, then working through an umbrella company might be the right option. If you’re open to getting to grips with the nitty gritty of running a business and are prepared for the responsibility and liability of being a company director, you will probably get a lot of out setting up a limited company.

Meanwhile, if you are only planning to contract for a year or two, an umbrella company might be the most hassle-free option, because once you go back to employment, it’s quick and easy to sever the umbrella relationship. If, alternatively, you have aspirations to grow your own business, then setting up a limited company for contracting is a great way of dipping your toe in the water and getting to grips with accounting responsibilities.

Both options are easier than you might think. Our consultants can easily point you in the direction of the government website through which you can get your limited company confirmed within 48 hours – or recommend a suitable umbrella organisation.

Give us a call today on 0161 714 0600 to learn more about what might be right for you.