Self-Employed vs Limited Companies: The Contractors Guide
Have you ever wondered why so many people toy with the idea of setting up a Limited Company? Maybe you are thinking about it yourself.
Perhaps you think it will be easier to find work or maybe you are thinking about improving your image and profile?
These are important considerations. Some clients prefer to deal with Limited Companies, others are more concerned about the quality of the work and the person actually doing the work, so in many cases confidence and trust in the person doing the work is the deciding factor, not the legal entity.
Why Set up a Limited Company?
The main reason for deciding whether to incorporate a limited company should be a commercial one and not one based on tax savings. Although this can be a beneficial side effect. Will presenting myself as a company improve my profile? Will it make it easier to market my business? Will it provide additional guarantees to me and my business partners?
At an early stage of your business it generally makes sense to keep things simple and work as self-employed. As the business grows you may want to think about establishing a limited company. However, the nature of your business, even at an early stage, may well dictate what arrangement you need to put in place. For instance, where there are several partners involved, consideration should also be given to the underlying agreement between each other. A Limited Company may provide a much better structure on which to build the business.
But what are the advantages of working self-employed as opposed to a limited company?
Advantages of being self-employed
- Simple accounting
- Only required to prepare a Tax Return once a year to HMRC
- Less expensive to run
- Not subject to Companies House and Companies Act requirements
- Not responsible for deciding the employment status (the contractor you work for has this responsibility)
Disadvantages of being self-employed
- National Insurance charged on net profits
- The Tax-Payer is personally liable
- An offset cannot be made between the CIS Tax Deductions suffered and the CIS Tax Deductions made from its sub-contractors. This can create major difficulties in terms of cashflow. (see CIS Considerations below)
If a self-employed contractor deducts £1000 CIS Tax from the payments made to his sub-contractors, the contractor cannot offset any of this tax against the CIS Tax Deductions he suffers at source, he will need to pay the tax over to HMRC every month. A self-employed can only make a claim for the overpaid CIS Tax at the end of the tax year. This is a major disadvantage compared to a Limited Company in the same situation whereby an offset is possible.
I have known clients who have built substantial businesses as self-employed, up to £1,000,000. However, lack of good accounting records has meant in some cases that penalties have been issued by HMRC to the individual rather than the business. Furthermore, the individual is liable for the debt the business may have with Creditors or HM Revenue & Customs. For example late VAT registration or incorrect CIS returns have resulted in the self-employed having to personally cover the debt of the business.
Advantages of a Limited Company
- A separate legal entity from its owners
- Liability of the company owners limited to the value of the shares (Normally nil as the shares are generally fully paid). For example any tax due is the responsibility of the Limited Company and not of the individual. The same applies to other debts. (However, the directors must trade responsibly otherwise if they trade when the company is insolvent, they may become personally liable)
- No National Insurance due on the payment of dividends hence more tax efficient (However from April 2016 this benefit is restricted to the first £5,000, after that tax is charged at 7.5% up to the basic threshold.
- A more attractive corporate identity (especially to banks and clients)
- More suitable if individuals needs to be employed by the business
- An offset can be made between the CIS Tax Deductions suffered and the CIS Tax Deductions made by the Company from its sub-contractors. This is very important in terms of cashflow advantages. (see CIS Considerations below)
Disadvantages of a Limited Company
- More expensive to run
- More complex legal and reporting requirements
- Accounts must be filed at Companies House and published
- IR35 may apply. This is a piece of legislation intended to stop individuals from forming a limited company when they should be employed by the contractor. The sole purpose of this arrangement is to have a tax advantage. Where IR35 applies additional tax liabilities become due
The Bottom Line
It’s very important to make right decision as to whether you should be self-employed or form a Limited Company. The implications are important and costly. If you would like to discuss the advantages and disadvantages of both arrangements as described above in a more detailed and personalized manner, you can contact us on the details below for a totally free, no obligation discussion.