Historically, the majority of IT contractors worked through their own limited companies. The tax advantages of working this way far outweighed any other method.

But with the introduction of IR35, these tax advantages may have been removed depending on whether you fall within the new IR35 rules or not. As a general rule, if you fall outside the IR35 rules then you’ll most likely better off using a limited company, otherwise an umbrella company might be the best bet.

The options available to you are:

• Your own limited company
• Umbrella company
• PAYE through the agency

1. Your own limited company

The vast majority of IT contractors work through their own limited company.

If you wish to set up your own limited company, you can use the Contractor UK Company formation service which enables you to complete the whole process online within a matter of minutes. You new company will be ready to trade within a few hours. You can check here to see if the name you require is available. Alternatively, you can apply for a limited company direct from Companies House (but be aware this will take longer).

Once you’veve set up your limited company, you’ll need to fulfill a legal requirement by appointing a company secretary to record company meetings and perform administrative duties. In practice, this role is minimal and should not take up much time during the company year. Many contractors appoint their partner, or a parent.

2. Umbrella company

An umbrella company provides a ready-made invoicing vehicle for contractors, while also removing the administrative duties normally associated with contracting in the form of a personal service company. The umbrella company normally issues invoices on the contractor's behalf, collects payments from clients/agencies, calculates tax and National Insurance contributions and pays the contractor their net pay directly into their personal bank account.

Traditionally, umbrella companies were more expensive than running your own limited company, mainly because their charges included all the administration overheads, and they tended not to offer the same tax advantages.

With the introduction of IR35, the tax disadvantages of umbrella companies have been reduced and a new breed of internet-based umbrella companies have emerged.
Variations on umbrella company schemes include managed companies and composite companies, although we would recommend taking expert advice before joining any such schemes as they are more complicated in nature than the traditional umbrella schemes.

3. PAYE through the agency

Some agencies allow you to become "PAYE" through their own payroll service.
This is the least tax-beneficial option available to you because it means you pay full tax and
National Insurance (NI) contributions on all your earnings. In addition this option doesn’tallow you to claim valid business expenses which would help to reduce your tax and NI liabilities.

Further links:

 - I've got my first contract: does IR35 apply to me?
 - Understanding section 660a
 - Contractor finance

 - Find an IT job

Disclaimer: the information on these pages is provided for your information and reference only. Before making any important decisions regarding your employment or any legal matter, you should consult a qualified professional adviser who can provide specific advice based on your individual position.

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