Deciding which trading model to use is a biggie for any contractor starting out. The new the Agency Workers Regulations, which became law in October, may also have a bearing on your choice. AWR can compel freelancers to go on the payroll if they work for a client on site for more than 12 consecutive weeks. Check the CWJobs lowdown.
Limited company: Risks the teeth-sucking factor
Many IT contractors have met with the following teeth-sucking response from an accountant when they’ve enquired about setting up a limited company: “Ooh, it’ll be complicated - and costly”.
That’s because you are setting up a legal entity with you as director and there is a lot of paperwork to do including P35s, P11Ds and other dealings with HMRC, and making submissions to Companies House. However, there are tax-efficient benefits that offset the additional accountants’ fees, such as being able to pay yourself a small salary and the rest in dividends.
Darren Fell, managing director of online accountancy, Crunch, reckons the new AWR makes the limited company even attractive because its legal status protects the IT contractor; using an online accountant means it doesn’t have to be expensive, either, he says.
“I set up my Limited Company (with Crunch) in a day. All the checks were done and I got my company registered with Companies House in about four hours.” David Johnstone, HiTech Magic
Umbrella company: Easy but potentially costly
This is a managed service for contractors with the umbrella company sorting out above and beyond sorting out tax affairs. Extra financial services include dealing with expenses and billing clients.
Received wisdom is that this is a model that suits a bullish economy and high-earning contractors who want to make hay while the sun shines. With the outlook of a double-dip looming, the umbrella looks distinctly less attractive and some pundits think the AWR may also have a bearing.
“If I was starting out again I would never set up a limited company I would use an umbrella company and have them take care of everything and just leave me to work.” Melvyn, IT interim manager.
Sole trader: Simple but untenable
In many industries, a worker who wants to freelance can simply register themselves as self-employed with HMRC and then do a tax self assessment each year (although many choose to hire an accountant to do this).
For taxation purposes, your personal and business affairs are treated as one. While this may be cheaper to administer, the downside is that unlike a limited company, you are personally liable for the finances of the sole tradership. If anything work goes wrong in your work, may come knocking at your front door.
However for IT contractors, this is rarely an option because most contract work is sourced through agencies, which treat the contractor as an 'employee' and deduct PAYE and national insurance at source.
“Employment agencies won't touch Sole Traders with a barge pole. There are laws in place preventing them from hiring someone in that capacity.”
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PAYE: Better the devil you know?
Given that so much work comes through agencies, some contractors choose the path of least resistance and become "PAYE" on the agency’s payroll.
This is the least tax beneficial option available to a contractor as you pay full tax and national insurance (NI) contributions on all your earnings. In addition this option does not allow you to claim valid business expenses which would help to reduce your tax and NI liabilities.
