Contractors can present themselves for employment in a number of ways, ranging from employee to offshore company director. Make sure you take the approach that suits your circumstances best. It is important to consider the structure of your relationship with companies you do business with. There are a number of options, according to accountants Forbes Young.
As an employee of an agency. This is a simple option but isn’t really about running your own business as you are still an employee. You might do this as a very short term option, particularly if on a relatively low rate of pay.
Sole trader. This is the simplest and cheapest way of being your own boss. There are only a few formalities to setting up and trading this way, the most important of which is informing the taxman. You are required to prepare accounts each year and they will form the basis of your tax and national insurance contribution (NIC) calculations. Any profits generated are automatically yours. The business of a sole trader is not distinguished from the proprietor’s personal affairs so that if there are any business debts, you are legally liable to pay those debts.
Partnership. A partnership is an extension of being a sole trader. Here, a group of two or more people will come together. It is advisable to draw up a partnership agreement which sets the rules of how the partners will work together, how they will share out the business profits etc.
Partners are taxed in the same way as sole traders, but only on their own share of the partnership profits. There is a variation of the partnership format called a limited liability partnership (LLP) which limits the liability of partners for debts incurred by the business if things go wrong, but LLPs are mostly suitable for larger accounting and legal firms. It is fairly rare for a contractor to supply their services via a partnership.
Your own limited company. A limited company is an ‘artificial’ person that can trade, sign contracts, own assets and incur liabilities in its own right. Your ownership of the company is recognised by owning shares in that company but it is still a separate legal entity from its owners. It is termed a ‘limited’ company because the personal liability of the owners is limited to the share capital that has been invested, which can be as little as £1.
If you also work for the company, you are both the owner and an employee of that company. When a company generates profits, they are the company’s property. Should you wish to extract money from the company, you must either pay yourself a dividend, as an owner, or a salary, as an employee. The advantage to you is that you can have a balance of these two to minimise your overall tax and national insurance liability. Companies themselves pay corporation tax on their profits after paying your salary but before your dividend distribution.
Umbrella company. Umbrella companies are limited companies operated by a specialist provider that groups a number of contractors under one company. Contractors using this structure become employees of the umbrella company and then submit regular timesheets and expenses (normally online) and then leave the rest up to the umbrella company. The umbrella company will generate and send invoices to the agency or client, chase payment when it’s due and then upon receipt of payment calculate your tax and national insurance and transfer your net pay direct to your bank account. The umbrella company provider will takecare of all accountancy and taxation matters and also deal with the bulk of the administration.
Offshore company. Offshore arrangements come in a variety of schemes. They seek to avoid a large chunk of tax being deducted from your earnings by channelling your income through a company or partnership or trust based outside the UK tax jurisdiction e.g. in the Isle of Man, Jersey etc.
However, you should be very careful using these schemes as the taxman is taking an increasingly aggressive stance towards them. Unusually, the taxman has the power to retrospectively apply the current rules to past income. Thus you could end up being personally liable for unpaid tax, penalties and interest if a particular scheme you get involved in is subsequently investigated and falls foul of current legislation.