As you enter the world of contracting, you face an important choice:
How should I manage my contracting income? Should I incorporate into a limited company (the option to work on a self-employed basis does not really apply to the type of contracts prevalent in the IT industry) or should I join an umbrella company and receive a net income from which PAYE and NI has already been deducted?
New legislation prevents The Bridge from advising you which route would serve you best, but we are able to lay out the facts in order that you might make an informed decision.
Limited Company – Personal Service Company
If you form your own limited company, also known as a personal service company or PSC, eg Yourname Computing Limited, you will be able to invoice for the work that you have performed, set off expenses that your company has incurred against that income and treat the balance as profit, from which you can pay a dividend (a share in the profit). Provided the work you perform is under contracts which meet the requirements of IR35, the amount of tax that you will pay may be lower than that you would incur by other routes, so your net pay may be higher.
A qualified accountant, acting in his or her professional capacity, will be able to assist you in setting up your own limited company and in performing vital tasks like the preparation of accounts. Their help is to be welcomed as they should understand precisely how to optimise your finances, which would more than justify their fees. You meanwhile would rapidly learn to handle simple tasks like preparing invoices and recording expenses without any assistance.
By taking this route, you would have to face certain administrative headaches throughout the year, like making VAT returns and keeping detailed records, but it is possible that you would conclude that the tax advantages would outweigh the extra effort involved.
Managed Service Company
There are a number of accounting services providers which also offer to help you by setting up a company for you and perhaps becoming involved in other aspects of the company’s administration, like issuing invoices or handling bank transactions. You should be aware that some, although not all, of these businesses will be providing you with what is known as managed service company (MSC) services. Recent legislation has been issued which greatly alters the tax treatment of any company deemed to be an MSC, such that your net earnings would be greatly diminished. The extra tax can be applied retrospectively so that you could face a very large bill several years down the line if your service provider failed to satisfy the authorities that they are not a MSC provider.
WARNING: some MSC providers also offer (or claim to offer) professional accounting assistance to PSCs. However, those PSCs will be classed as MSCs if any of the other activities of the MSC provider are pounced upon by the inland revenue under the new legislation, even if their activities are legitimate!
In other words, choose your accountant wisely.
Several large organisations have established themselves in the last ten years or so as a viable and safe alternative to incorporation. They run a large limited company (an umbrella) of which you the contractor become one of many employees. They carry out all the invoicing on your behalf and credit your personal bank account with pay net of all taxes. This is different from a MSC provider in that the latter forms a different company for each contractor and makes the contractor a shareholder in the individual company.
In tax terms the umbrella route is not very different from being a normal employee although certain business expenses may be tax deductible to slightly improve the net earnings. The advantages lie in the simplicity of administration and the flexibility to move in and out of the scheme at the drop of a hat. Many contractors start down this route as a hassle-free way to see if contracting is a life that suits them.
If you would like further information on the options available to you, please contact our office.