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There are many advantages to making the move from permanent employment to contracting. From higher take home pay, to the freedom to choose the projects you work on, and the flexibility to work the hours that suit you. If you have decided to leave the office politics behind and work on a contracting basis, our guide will help you understand the obligations involved in being your own boss.

What is the best way for me to operate as a contractor?

The two most common ways for contractors to operate are through an umbrella company or by forming your own limited company; both options come with advantages and disadvantages.

The advantage of using an umbrella company is that it provides a minimal commitment method for those that aren’t yet sure if contracting is for them or who are only planning on contracting for a short period of time (usually three months or less). The disadvantage of using an umbrella company is that it is the most expensive way to operate as you will be subjected to full tax in the same way that a full time employee would be. Another negative side to contracting under an umbrella company is that you must hand over control to the umbrella company as you rely on them to collect your earnings from your client on your behalf.

Limited company ownership is a popular way to operate as a contractor because it is widely considered to be the most tax efficient way to work. As a limited company you have access to a range of tax saving opportunities such as the Flat Rate VAT scheme and you will also retain control over your business. Operating through a limited company comes with administration responsibilities amounting to approximately 15 minutes worth a month.

What is the process involved in forming a limited company?

Many potential contractors are under the impression that forming a limited company is a lengthy and costly process. However, it can usually be completed within one working day and if you decide to appoint Nixon Williams as your contractor accountants we will form your limited company free of charge. For further advice on forming a limited company please click here.

What is involved in running your own limited company?

Limited company directors must take responsibility for their tax, national insurance and finances; they therefore have a certain amount of administration responsibilities to complete. This includes completing an annual return and submitting it to Companies House, completion of your annual accounts, invoicing clients, paying taxes and keeping track of business expenses.

Many limited company contractors choose to appoint an accountant who will help them with their tax obligations. The cost of appointing an accountant is often less than the fees that umbrella companies charge, which is another advantage to contracting through a limited company.

Starting out in contracting

What is involved if I choose to contract under an umbrella company?

If you were to employ the services of an umbrella company they would essentially act as your employers, in that they will collect your earnings from your client, deduct your tax and national insurance contributions plus their company fee and then pay the remainder onto your via the PAYE system.

If you are still unsure of which business structure is right for you, our Limited Company or Umbrella page will be useful.

How much of my contract will I take home?

Increased take home pay is one of the main reasons why many workers are attracted to the contracting way of life, but the amount that you can actually take home will depend on a number of factors including how you operate. We have already said that contracting under an umbrella company is the most expensive way to operate, with contractors typically taking home around 60-65% of their contract rate. We have also said that limited company ownership is generally considered the most tax efficient way to operate and if you are working in this way you will take home approximately 75-80% of your contract rate.

If you already know what your daily rate is going to be then use our take home pay calculator to get a clearer idea of the amount that you could be taking home.

What expenses am I able to claim as a contractor?

One of the benefits of contracting is the ability to claim costs that you have incurred wholly and exclusively for business purposes as business expenses, which means that you will receive tax relief on the cost. Some examples of costs that you could claim as a business expense are:

When claiming expenses it is vital that you keep a copy of your expense receipts in case HM Revenue and Customs (HMRC) ever ask to view them. It is generally recommended that you keep copies of your receipts, either digital or paper, for six years following the end of the financial year that the expense was incurred in.

tax question

How do I know if I am caught by IR35?

IR35 is a government legislation that was brought into combat what HMRC deem to be disguised employment, with the aim of preventing contractors from receiving the benefits of permanent employment as well as the benefits of contracting. Whether you contract is inside IR35 or caught by IR35 will depend on a number of factors including control, financial risk, access to equipment and your notice period. IR35 only affects limited company contractors because if you are working under an umbrella company you are classed as an "employee” of your umbrella company scheme.

For more information on IR35 you may find our What is IR35 – The Complete Guide page useful, or if you already know the terms of your contract use our IR35 Checker.

If I am inside IR35 should I still form a limited company?

If your contract is caught by IR35 and you are working through a limited company then you must declare that is the case and you will not be able to claim the same benefits that you would be entitled to if you were contracting outside of IR35. That being said there are still advantages to working as a director of your own limited company rather than under an umbrella company, these include access to the Flat Rate VAT scheme and being entitled to 5% tax relief on your earnings to account for business running costs.

For more information about becoming a contractor, please get in touch with a member of our new business team who will be happy to answer any of your questions on 01253 362062 or email newbusiness@nixonwilliams.com.