If you're thinking about making the move into the world of contracting, one of the first things you will need to think about is your business structure.
Clients may hire you either via a direct contract, or through an agency, but in either scenario you can choose to operate under an umbrella company or as your own limited company, and each has advantages and disadvantages.
If you've always dreamed of being a company director, setting up your own limited company will allow you to do just that! Unfortunately being a company director comes with a set of statutory financial obligations. Basically you will just have to submit your annual accounts to Companies House, and meet submission deadlines and tax liabilities with HMRC, all whilst running your business solvently and responsibly.
Whilst the ultimate responsibility lies with you as director, a lot of the heavy lifting can be done by an accountant. Many contractors operate as a limited company, so the market is awash with accountants who specialise in working with 'one-man' operations. After a period, it's likely that you'll learn enough to process your own accounts, but using an accountant takes out a lot of admin time and is a sound investment, allowing you to concentrate on your actual business.
The main reason contractors use a limited company is that it's the most tax efficient way to operate. This works by paying yourself a low salary (often no more than your tax-free personal allowance), then drawing the rest of your income from the companies profits in the form of dividends. By splitting your salary in this way, you can make a significant saving in contributions, as dividends are not subject to National Insurance deductions.
Another benefit is the flexibility it offers for withdrawing income from the company. This can help you reduce your tax contributions with careful planning, and also offers the opportunity to transfer some of your 'shares' to your spouse in order to utilise their personal allowance, when appropriate.
Corporation Tax is due at a rate of 20% on the company's annual profits. You may or may not need to register for VAT depending on your businesses income, and whether it's a requirement of your client(s). If you do register for VAT, you add it onto all invoices you send to your clients, and make payments to HMRC on a quarterly basis.
Forming a company is simple. You can do it directly with Companies House for around £20, but if you're planning on recruiting an accountant, they should be happy to do it for you, whilst also taking care of the registration process for the corporation tax and payroll.
Using an umbrella company is a more hands-off approach, but as a result it's less tax efficient. Basically you will be enlisting the help of a third party supplier, who act as an employer on behalf of it's contractors. When you land a role, the contract exists between the umbrella company and recruitment agency – or end client, on your behalf.
The umbrella company puts you on their payroll, and processes all time-sheets and invoices before making the relevant deductions, and paying you a salary. As a result you can expect to pay a set fee, or small percentage of your salary to cover the umbrella companies services. The rates vary so you can really benefit from shopping around and making enquiries first.
Whilst you'll end up with more deductions, you should still be earning more than if an employee in the same post. It also provides a useful method for those wishing to just try out contracting for a while, or those that wish to drift in and out of contract work – basically it's hassle free, assuming that you found a reliable provider.
The other thing to consider is that operating under an umbrella company offers no chance to get caught by 'IR35'. If you're thinking of operating under a limited company, you should take a look at our guide Don't Fall Prey to IR35, which details the government's attempts to cut down on 'disguised employees' working as contractors.