In the UK there are three different ways to work as a freelancer or contractor; Sole Trade, Umbrella Company or Limited Company. What the best option for you is, depends on your situation. In this blog post I try to explain in a simple way the differences between them. I also made a list of the Pros and Cons on each one of them and an illustration on how they will impact your income.
This is a small business owned by one person. A Sole Trader takes on all the responsibility for running the business and is allowed to keep the profits after Tax is paid, but... he or she is also fully liable for any losses the business makes! Setting yourself up as a Sole Trader is very simple, you only have to register your company and you can start trading straight away. Being a Sole Trader also allows you to hire staff, because even though it is run by one individual, it doesn't mean that you have to work alone.
An Umbrella Company basically acts as your employer. You submit the amount of hours you worked online and they handle the rest. They invoice the client and pay you after the deduction of Tax, National Insurance, any expenses you made and of course.. their own fee. This way you don't have to deal with the paperwork. You enjoy the freelance lifestyle, but technically you are an employee of the Umbrella Company.
When you set up a Limited Company you become the Director of your own business. You can also set up a company with multiple people / shareholders. There is quite a bit of paper work that goes into it, but in this way your company is responsible for its own legal and financial decisions. It's finances are separated from your personal finances and your company pays you a salary. Any profit that you make is owned by the company and Corporation Tax has to be paid on this. Whatever is left can be withdrawn from the business by the Director as Dividends. And this is more tax-efficient!
pros and cons
- Any profit after tax is yours to keep
- You have control over your own business
- Less paperwork
- Accountants charge less for sole traders
- Maximum privacy
- You are fully liable for any debt or losses
- No distinction between private and business assets
- Scalability is limited
- Difficult to get large contracts as it has less professional credibility
- Limited lifespan
- Very easy to use
- No paperwork or dealing with HMRC
- Ideal for when you are in between permanent jobs or unsure if freelancing is for you
- The ability to claim back expenses such as travel, meals, tools etc.
- You take less money home as there are greater tax charges
- Low status. Clients might think you are not as established or experienced
- Less control
- Most tax-efficient
- Claim a wide range of expenses
- No personal risk
- High status
- Able to set up a pension scheme
- Complete control of your business
- Protection of company name
- The paperwork and administration
- Less privacy. Accounts and other details are held on public records
- Accountancy fees are high
- Paying Corporation Tax