PAYE Umbrella vs Personal Service Company
Introduction
In theory, it should be perfectly feasible to operate as a sole trader, producing your own accounts and completing a self-assessment income tax return at the end of each year. You would need to advise your local tax office of your status and you would be responsible for paying your own tax and class 2 and class 4 national insurance contributions.
In practice, however, this is not always a suitable way of proceeding because the majority of clients and agencies insist that freelance contractors operate under the banner of a limited company.
There are five very sound reasons for this:
- To avoid employment agency legislation including possible PAYE complications
- Your clients avoid the legal burden of employing a permanent member of staff (minimum wage, redundancy, SSP, maternity leave etc)
- Your clients have no hidden employment costs (pensions, holiday pay and other long-term overheads)
- Your clients have no responsibility to operate PAYE on your consultancy fees. This is extremely important, since if you are a sole trader, the Inspector of Taxes could dispute your status and, in certain circumstances, look to your client for income tax and National Insurance on your fees, long after employment has ceased
- Being employed by another limited company is indisputable proof that you are not employed by your client (although not for IR35 purposes)
For the reasons given above, you will find that your decision has been made for you by your ultimate client. Almost without exception recruitment agencies and end clients will only recruit freelance contractors who operate through a limited company.
Freelance Contractors have two options for setting up a payment structure:- Own limited company (also known as a personal service company), or
- Umbrella company
IR35 and Financial Considerations
It is important to emphasise at the outset that the choice does not in any way influence the IR35 status of your contract. Your choice will not influence any HMRC review or decision as to whether the contract falls within the IR35 regulations.
Key Differences between a Personal Service Company and an Umbrella Company
Personal Service Company
Forming your own company means that you will be running your own business. You will be a company director, operate the company bank account, and be responsible for the affairs of the company.
Benefits
- If you contract is not caught by IR35 legislation this is the most tax efficient way of working; you get to keep more of your income;
- You have complete control of your financial affairs and company matters;
- You are running your own business so you can undertake other work outside your normal contract role;
- You can legitimately claim a wider range of expenses (training, equipment, software, etc);
- Contractor status, as you will be seen to be "representing" the company and "running a business" with its own trading name.
Disadvantages
The new MSC legislation has made this type of solution an extremely high risk if you seek help for the day to day chores (invoicing, payroll, book-keeping, and so on) as the supplier of these services may at some point in the future be deemed to be a Mangaed Service Provider, if so you may be liable to additional taxes that will be back dated to 6th April 2007. In addition:
- As director you are responsible for maintaining company accounts and compliance with all company and other statutory matters;
- There are various deadlines which if missed could incur penalties;
- You are responsible for day to day issues as invoicing, keeping a simple accounting system and ensuring all forms, returns and accounts are filed by the due dates;
- Cost of liquidating the company if you decide to cease trading;
Many contractors, particularly first timers do struggle with these responsibilities.
Joining an umbrella service means you essentially become a PAYE employee. Whilst you retain the freedom to work where you want, and for the time you wish all the company administration is done for you. The umbrella company will contract with the agency/end client and provide you with a contract of employment.
Benefits
- Very easy to use, all tax and NI deducted before you get paid;
- For short term contractors you only pay for the service when you are paid, you will not be charged between contracts;
- The umbrella company provider takes care of all accountancy and taxation matters and also deals with all administration matters.
- The contractor completes a timesheet and forwards it to the umbrella company, who then invoices the agent.
- Avoids time and trouble of running a limited company. After a simple set up, the contractor completes timesheets and forwards to the umbrella company.
- For short term contractors, a main advantage is not having the costly process of forming a company and then arranging for it to be dissolved and there are none of the responsibilities associated with running a limited company.
Disadvantages
- You are reliant on the Umbrella Company to collect your money from the client or agent and then to pay it on to you;
- You cannot represent yourself as running your own independent business;
- There is inevitably some delay in the contractor receiving their money, since it needs to pass through a third party account before reaching them. This is down to the efficiency of the umbrella company.
- There is an element of trust on the part of the contractor, since their money will be passing through the third party umbrella company bank account.
Making the Right Choice
In making the right decision you will need to weigh a number of factors based on your own circumstances and requirements. There is no "always right" or "always wrong" solution - both methods will work for you but with different working arrangements. In making your decision, we suggest you consider the following criteria:
- Length of contract -
- Administration
- Not Sure
- Caught by IR35
- Status
Why not sign up with us now for our umbrella services. We are one of the best and most knowledgeable companies in the business.