International contractors have a choice when it comes to how to structure their business with clients. This is either through a direct contract or using a third party. When you contract directly you can do so as to either be a sole proprietor in your name or as a limited company. The third-party route would use an umbrella company as a go-between for you and your client.
The issue is how to decide whether to use either a limited or umbrella company. This guide will outline the differences and potential pros and cons of both options.
What is an Umbrella Company?
An umbrella company is a third party that acts as an intermediary between you and your client. They receive payment from the client, withhold taxes, make social contributions and ensure the terms of the contract are met for both parties. You submit your invoice and they issue you a payslip each month.
This can be especially useful if you are an international contractor and entering a country that you are unfamiliar with. An umbrella company can help make sure that you stay in compliance with local laws, including taxation, registration and licensing.
What is a Limited Company?
A limited company is a way for you to offer your service as a contractor, using a separate entity that is formed with you named as a company director. You will have to run it as a business, which includes registration, incorporation and submitting annual reports just like any company. The invoices to your clients would be sent under the name of the limited company and will be paid directly by the client.
If you are taking your work abroad, you will have to operate as a business in a foreign country, meeting rules on work visas, taxation and local registration. This is an added layer of complexity if you are used to only doing business in your home country.
What are the pros and cons of contracting by using an umbrella company?
Advantages of contracting using an umbrella company
- Firstly, the use of an umbrella company is ideal if you are engaging a new client, or are contracting for the first time.
- It can be set up quickly for a short-term contract, once you have selected an umbrella company.
- The umbrella company takes care of invoicing your client, withholding taxes and processing payments.
- Their role gives your client peace of mind on project performance, and you don’t have to worry about getting paid on time.
- Lastly, if you are an international contractor, the umbrella company can sponsor your work permit. They can also make sure local immigration rules are met.
Disadvantages of contracting using an umbrella company
- An umbrella company may not be an advantage if you already have established client relationships, and are comfortable handling your tax and withholding.
- You won’t have full control over your invoicing and tax payments. You have to rely on the umbrella company to make correct payments and contributions.
- You don’t have the tax benefits as you would with a limited company, and will pay taxes as an employee would.
- There is a fee for the umbrella company. This could reduce your net income unless you can pass the cost on to the client.
- It is better for use with a single client, rather than multiple projects at the same time.
What are the pros and cons of contracting by setting up a limited company?
Advantages of contracting by setting up a limited company
- Using a limited company can be beneficial for contractors that want the flexibility and savings of a corporate tax structure.
- You can allocate your income as salary or dividends for maximum tax savings.
- It gives the appearance of professionalism to your clients.
- A limited company is a good choice if you have multiple clients that you work with.
- It limits your liability and gives you control over your business and finances.
Disadvantages of contracting by setting up a limited company
- You will have to hire an accountant to handle the complex aspects of your financial and tax picture.
- You will have to meet all of the statutory and reporting rules. You have a responsibility that they are submitted on time even if prepared by your accountant.
- You would also have to buy your insurance coverage, whereas the umbrella company would provide that for you.
- As a limited company, you have to make sure that you meet local business requirements when working in a foreign country, as well as find a way to obtain a work permit.
- It is not suited to short-term contracts.
A quick comparison: Umbrella company VS Limited Company
The best way to compare these two options is to recognize that both are using a separate entity to contract with the client. This is either a limited or umbrella company. Your choice will come down to
- whether you want to have control and responsibility for your limited company,
- or if you prefer to put the umbrella company in that role.
With the umbrella company, you have full administrative support. With the limited company, you are a formal business owner, and those are two very different ways of operating. Remember, there are also costs associated with each, and the limited company is probably best if you have higher-paying clients and are an established contractor. Those just starting out or with lower-paid engagements will find the umbrella company a simple and easy way to handle payment processing and withholding.