To operate as a contractor you will have to have a private limited company, or use an umbrella company or other such scheme to get paid. In this article I aim to outline how to do each and the pros and cons of each choice.
Private Limited Company
The vast majority of Contract Project Managers work through their own Private Limited Company. The term ‘limited’ derives from the fact that the company’s finances are distinct from the personal finances of their owners (unlike sole traders).
PLCs (public limited companies) differ from Private Limited Companies in that they are allowed to offer shares to the public to raise funds (with shares issued to a minimum value of £50,000).
Private Limited Companies cannot offer shares to the public, but may have any number of shareholders. Each Private Limited Company must have at least one director to make management decisions and a company secretary.
Setting up a company is often offered as part of an accountancy service, or by companies who will do all of the application and documentation for you for a small fee. This can be done by you direct with Companies House, but can take longer and for a small fee it is often more cost effective to use the intermediary companies (or your accountant). The following documents will be completed as part of your company:
1) Memorandum of Association – Includes Company Name, Location and Type of Business
2) Articles of Association – Outlines Directors’ powers, shareholder rights, etc.
3) Form 10 – Provides Directors’ and Company Secretary’s Names & Addresses, together with the Registered Company Address.
4) Form 12 – States that the Company complies with the terms of the Companies Act
Steps taken to set up my own private limited company:
Choose a company name and instruct my accountant to set up the company in that name
Complete the required forms to set up the company
Set up a business bank account (as money paid to me from my contract is not mine – it belongs to the business!)
Employ an accountant to look after the business accounts
Pay my accountant for my payroll processing on a quarterly basis (around £100)
Pay my accountant for being my company secretary and registered office, mainly so they receive my business post – this is money well spent as I move house a lot! On a yearly basis (around £100)
Keep a copy of what I earn for VAT etc, and fill in my own VAT form every quarter (my accountant helped me with the first one and can do them all for me if required, for around £200 per quarter)
Ensure my accountant does a yearly statement on the company accounts and helps me complete a yearly tax return (around £1000)
Ensure contracts are written between the agency and my company name and as company director I am required to sign these.
Really that is it, it looks like a lot above, but there is very little admin once you are up and running. I keep a spreadsheet of when I am working and how much I am paid and the VAT amount etc, and it takes me 5 minutes a week to update that, then when my VAT form comes I fill it in, my accountant does the rest.
I can honestly say it feels no different to being an employee; you have to remember you are an employee of your own company. The money that goes into your business account is not yours, what belongs to you is the salary you agreed to take from the account – and you have to pay tax on that.
The advantage to using a Private Limited Company is; as long as you are claiming taxable expenses, you should be taking home about 65% of your gross pay. This is not bad, but the disadvantage is there is a bit of administration as above to keep on top of your back office.
This is where you, ‘ the contractor’, essentially becomes an employee of the umbrella company, a third party company who is between the contractor and the agency.
In the United Kingdom, an umbrella company acts as an employer to independent contractors who work under temporary contract. Recruitment agencies will only issue contracts to a limited company, however many contractors may work under one umbrella company, which saves them from setting up their own private limited company.
You submit time-sheets to the umbrella company who will invoice the end client (or agency) for the work done by you. You will then be paid as a PAYE employee less the umbrella fee.
An umbrella company is a good choice if you earn less than £25,000 per year, or are on a short contract and don’t intend to stay contracting for long, or prefer not to set up your own private limited company. Working through an umbrella company is simpler than working through your own limited company but it means you will take home less money from your contract.
How working through an Umbrella Company works:
The umbrella company will sign a contract with your recruitment agency
You will sign an employment contract with the umbrella company
You regularly submit both timesheet and expenses information to the umbrella company
The umbrella company will invoice your agent/client for the work you have done
The umbrella will receive funds for you from the agency
You receive your money less tax, NI contributions and the Umbrella services fee and your umbrella company will send you a payslip just as with permanent employment
The advantage to using an Umbrella company to get paid is the lack of hassle – Payroll, tax etc, is all done for you by the Umbrella Company. However the disadvantage is on average you will only take home around 55% of your gross pay.
Employee Benefit Trust
There are a number of contractors talking about being paid “offshore”
This usually means they are using an Employee Benefit Trust to receive their pay. This means an umbrella company that holds an account offshore. The contractor pays into this account and takes an interest free loan out every month from this account in the form of wages.
This method can gain more money to the contractor and it means paying less tax. But recently these schemes have been deemed as “tax avoidance” on 6th and 9th December 2010, HMRC released Ministerial Statements advising that legislation will be introduced to tackle arrangements involving trusts or other vehicles used to reward employees and that of disguised income. They also inserted an „anti-forestalling‟ provision to apply from the 9th December 2010 meaning that any payments (loans) or assets provided between 9th December 2010 and 6th April 2011 would be caught within the new legislation as though it happened on or after 6th April 2011.
This means that contractors using Employee related trusts (EBT‟s) and similar schemes will from the 9th December 2010 be unable to reduce their tax liability using these models and will be forced to look for an alternative solution or switch back to PAYE Umbrella.
Another alternative is a remuneration trust. This is a structure which has been used by high net worth individuals and corporate bodies for over 20 years in tax planning. The remuneration trust is a legally recognised entity provided for in both statute and common law.
You become an employee of a consultancy who contracts you out to your agency or client. The employment relationship is covered by an overarching contract of employment. The consultancy is registered as a PAYE employer and pays you a gross salary of £1,008 per calendar month, which will be subject to full income tax and National Insurance.
Once the consultancy has deducted your salary, they will elect to contribute the remaining profits from your assignments to the remuneration trust. The trust will then pay you your agreed % return of this contribution as a deep discounted commercial loan. As with all forms of commercial credit, this payment is not treated as income and therefore not subject to any form of taxation or National Insurance.
You will receive a signed loan agreement from the trust to evidence the existence of the loan. The loan will be rolled over every 10 years such that it exists in perpetuity and after death will be considered written off, as under English law debt cannot be inherited. The debt can actually also be used to offset against any inheritance tax due by your estate. Payments from the trust will be paid the same day as the trust receives the funds.
This does not fall into the statutory definition of tax avoidance as it is by virtue of your commercial
relationship with the trust that you are receiving the finance.
Involves no ‘tax avoidance’
Full disclosure to HMRC
Has never been challenged by HMRC in court.
Loans are not taxable as ‘disguised income’
Contributions are deductible in computing the profits of the tax payer company
Full employee status
Professional Indemnity Insurance on the whole structure of up to £2 million.
Has been used as sound tax planning for almost 20 years.
High percentage returns
APS Limited is the first company I have seen using this better structure and I have started to use them for myself. If you are interested in doing so too click http://www.contractorprojectmanager.com/referral or call 0844 5675657 and quote the reference “Contractor Project Manager.com”
Pay comparison of options
Below is a table comparing the typical pay with each option:
(Please note. The below figures are for illustration purposes only. The PAYE figures have been calculated using a tax code of 747L with applied £1,200 of taxable expenses)
There are a number of ways to be paid now and it is up to you which one you choose based on how much hassle versus risk versus money you prefer.