A Limited Company or not?
The Inland Revenue (IR) would like every worker in the country to be employed under PAYE. Why? Because that way they receive the full 40% tax deduction and they receive it monthly. Additionally, the employer undertakes all PAYE administration so the cost/benefit relationship to the Treasury is very favourable.
Those who are in business on their own account however are able to deduct expenses and pay their tax in six-monthly instalments. Additionally the IR has to set up a self-assessment file and spend time logging this data and ‘approving’ these Returns. The cost/benefit relationship to the Treasury has obviously dropped.
If you therefore leave employment and commence as a contractor, you have to show that you are in business on your own account otherwise the IR will ‘deem’ that you are still an employee and tax you as such.
Whether you have a Limited Company or not is therefore vital.
Limited Companies are prima facie trading entities. Their raison d’etre is to be in business and make profits. The worker owns the business and directs and controls how the entity will manage itself in the market, bringing rewards to the owner according to how successful it is.
Other entities offered to Contractors such as umbrella companies, composite companies and managed companies are not owned, controlled or managed by the worker, but by someone else (see bullet points below).
The IR therefore have long held the view, as recently published in Gordon Brown’s pre-budget report on the 6th December 2006, that such Managed Service Company Schemes (MSC) are not true businesses, at least as far as the worker is concerned, hence the long expected announcement that PAYE will, from April 2007, have to be deducted from those ‘rewards’ paid to the worker.
The only true trading vehicle for a Contractor is therefore within a Limited Company, and as long as the nature of your working relationship is outside of IR35, as verified in your contract, then only that portion of your reward you choose to take as salary, will be subject to PAYE.
- Umbrella Companies are vehicles where you are one of perhaps several hundred workers and where you are awarded expenses on top of a small salary with the remainder being paid to you as dividends. Your overall net reward is large, as is the management fee.
- Composite Companies are similar to but smaller than Umbrella Companies with perhaps only 20 workers; thereby ensuring the ‘holding’ company remains a small company for tax purposes. (Small companies pay less corporation tax than large companies)
- A managed Company is like the above but with only one worker.
- A Limited Company is owned, controlled and managed by the worker, usually with the assistance of an Accountant. There are regulations and deadlines to comply with but the accountants fee is considerably lower than that of a managed company.