The great contracting debate: umbrella or limited company; which is best for IT contractors?

With chancellor Jeremy Hunt’s new Spring Budget 2024 doing very little for limited company workers, it’s fitting to look at an age-old debate – working through a limited company or an umbrella company, which is best for IT contractors?

Choosing ‘umbrella’ or ‘Ltd’ for your next temporary technology assignment is an important decision, as it can have a significant impact on your take-home pay and your administrative responsibilities.

Let’s outline the key ‘pros’ and ‘cons’ of each contracting model to help you determine the best option for your tech contracting career, writes Crawford Temple, CEO of the UK’s largest independent assessor of payment intermediary compliance Professional Passport.

Working with an umbrella company – seven key advantages

Umbrella companies take care of all the payroll, tax, and administrative burdens on your behalf.

As an employee of the umbrella company, you simply submit your timesheets and they'll handle the rest.

The main benefits of choosing an umbrella company include:

1. Simplicity

You don't have to worry about paperwork, chasing payments, taxes, or other back-office tasks. The umbrella company handles everything for you.

2. Compliance

Reputable umbrella companies ensure you remain compliant with rules and regulations which should provide you with peace of mind.

3. Short-term flexibility

It’s easy to start and stop contracts via an umbrella company without long-term commitment. That’s very helpful  if you wish to take on lots of temporary tech roles.

4. Support

Umbrella companies provide you with HR, insurance, payroll, and other support you would expect as a conventional employee.

5. Benefits

You receive all the benefits, such as sick pay, holiday pay, maternity/paternity leave that you are due as an employee of the umbrella company.

6.  Cheaper

Umbrella companies typically charge you less money than an accountant supporting a limited company will typically charge.

7. Pensions

If you are considering making higher pension contributions some umbrella companies offer ‘salary sacrifice,’ which is very tax-efficient when operating through an umbrella company.

The potential downsides to umbrella companies must obviously be considered, and they are quite numerous.

Umbrella company disadvantages – top three

1. Higher tax = lower take-home

Your income is taxed like a normal employee.

This will typically result in a higher tax and National Insurance burden than if you were contracting through your own limited company where you are outside IR35/Off-Payroll, and structure your income for tax-efficiency.

2. You get no choice, maybe twice over

Where an end-user determines that the assignment is within the off-payroll rules, they typically insist on engaging the temporary worker via an umbrella company.

In addition, you may be required to use one of only a few umbrella companies on what’s called a Preferred Supplier List (PSL), further giving you little choice.

3. Umbrellas are unregulated

Despite calls to introduce regulation specific to umbrella companies, the government is yet to bring forward any such framework.

However, Spring Budget 2024 last week said the government would provide an update on that regulation. And that update will be a response to industry responses to government proposals to regulate umbrellas. Spring Budget said the government update would be outlined on Tax and Administration Maintenance Day which this year falls on April 18th 2024.

Operating as a limited company – top four advantages

Where the temporary technology role you’re going forward for is outside IR35, contracting through your own limited company allows greater control over your business and increased tax-efficiency.

The main advantages of a limited company include:

1. Tax-efficiency

By taking income as dividends instead of salary, you can significantly reduce your tax liability with HMRC.

2. Control

You control not only the overall day-to-day of your contracting assignment, but also the role’s (and your company’s) related invoicing, payments, expenses and other financial matters.

3. Business growth

As a company director you can retain profits to grow the business.

4. Purchase tech

You can purchase technology such as hardware/software with the company’s money, assuming such tech is wholly, necessarily and exclusively for your business.

Assuming certain HMRC criteria are met, you’ll have a significant number of allowable business expenses.

But as a limited company, it’s not all plain sailing!

Potential disadvantages of a limited company include these five:

1. Admin responsibilities

Directors have statutory filing and reporting obligations. You will likely want an accountant to help you follow rules laid down by both HMRC and Companies House.

2. IR35 concerns

With the recently revised IR35 legislation in place, your hirer is responsible for determining your employment status as to whether you are inside or outside IR35 (except if the end-user is a ‘small company,’ where they are not responsible for this determination – you are).

The introduction of the off-payroll legislation prompted many contractors to work through an umbrella company. If you have a limited company and find that clients insist you operate through an umbrella, it can be costly and very time-consuming to close the company down.

3. Delayed payment

The buck stops with you as a limited company contractor in IT (or any other sector), meaning you have to invoice clients and chase payment where agencies and/or clients don’t pay or drag their feet in paying you.

4. No benefits

Operating as an employee of your own limited company means you are responsible for ensuring you have enough money to live on should you become sick or want to take a holiday.

So there’s very few of the benefits which umbrella company employees (and direct employees of the end-client) receive as standard.

5. Concerns over Managed Service Company Legislation

The MSC rules are arguably the toughest framework for a ‘LTD’ contractor to come up against. That’s because ensuring your accountant is not caught by this legislation is very hard for you, the contractor, to assess!

However, there are current court cases pending which will help clarify this issue of exposure to the 2007 legislation.

If you do end up being caught by the MSC legislation in HMRC’s view, your income will be taxed on almost the same basis as if you were in an umbrella company -- even if you were operating outside IR35.

Which is best for your tech contracting career; umbrella or limited company?

Unfortunately, there's no definitively ‘right’ answer – it depends on your personal situation and priorities as a temporary technology professional.

When deciding between working as a limited company contractor or through an umbrella company, there are several key factors to weigh up and to reiterate - there is no-one-size-fits-all answer as to which model is best.

In short, a limited company typically maximises income for higher earners willing to handle their own admin and legislative risks, like MSC and IR35 rules.

By contrast, for technologists who prioritise simplicity over maximising pay but who have a stomach for (currently) unregulated structures, an umbrella company is likely to be preferred.

Lastly, times change…

Finally keep in mind – whichever structure is ‘correct’ for you now, may not necessarily be ‘correct’ this time next year. As your contracting career develops, your needs may change. Don't be afraid to switch between an umbrella and a limited company as your circumstances evolve. The important thing is making the right choice to meet your needs -- and making the most informed choice possible.