18 Jul 2014

If you have been given the choice to work on a PAYE basis via an umbrella company or form and work through your own limited company (often referred to as a PSC) there are many important factors to consider and we have listed some of the pros and cons of each which should hopefully assist in making a decision.

PAYE – Pros                                                       

  • If you are only planning on temping on a short-term basis, PAYE will be much more attractive then setting up a company, running it and then closing it.
  • Lower costs – the costs of running a company are generally higher, you will have to have company accounts prepared and submitted for a start and will have to have your own insurances all of which can cost a few pennies.
  • Lesser admin burden – there is more paperwork involved in running a limited company so if paperwork is not your friend, PAYE could be more suitable. You would have to register for real time information and do monthly and yearly returns. If you miss the deadlines for the returns you will be hit with penalties.
  • Mortgage – if you plan on applying for a mortgage soon, PAYE may be better because if you form a limited company many lenders will want to see a few years accounts and even then may consider it a risk so lend less as a result.
  • Tax and national insurance – is all dealt with, you have no risk provided you do not falsify expenses.

PAYE – Cons

  • The agency or umbrella overheads are higher if you are PAYE so from the money you would have been paid before, the company will now have to account for things like employer’s national insurance, holiday pay and possible pensions meaning the gross rate you would normally achieve would be less than before.
  • An agency cannot pay you expenses tax free such as travelling to work and back whereas an umbrella company can (which is the main reason they are used) but if don’t actually incur many expenses, the increase in overheads above means you will lose out and PAYE umbrella may not be the most suitable option.

Ltd Company – Pros

  • You can be paid a basic salary and the rest by dividend which usually means you take home more than if you were PAYE.
  • The agency no longer needs to pay employer’s national insurance, holiday pay and into a pension fund meaning that the rate your company receives will be higher than if you were PAYE.
  • Income splitting – if you are married, it may be possible to arrange your affairs so that you can use the tax allowances of your spouse to maximise your household take home pay – separate advise should be taken out if this is intended however. Our other business Assured Tax Consulting has extensive experience in the area of income splitting and can advise as to whether this may be possible or would create problems.

Ltd Company – Cons

  • Ltd companies are usually only beneficial for people on a higher rate of pay because of the additional costs of running a limited company and preparing accounts.
  • Tax – not only do you get paid gross and have to put your tax money aside you also have to comply with many other tax laws such as the agency legislation, the MSC rules and IR35. If any of these apply, you will be hit with significant liabilities which can be transferred to your personally. It is therefore essential that you take out sound tax advice on this structure and on an on-going basis to ensure you don’t find yourself saddled with a liability in years to come.
  • MSC rules – mentioned above but worth its own special mention. You have to be prepared to put a bit more work into running the ltd company, if another company effectively says they will set the company up for you and run the admin side on your behalf, the MSC rules could quickly apply. To be safe, only engage the services of accountants to help you not companies offering various payment solutions including setting you up with a company and running it for you. This is of paramount importance and cannot be understated.

The best route will depend on your circumstances but the above points should give a few pointers to consider before taking the plunge. Some contractors that are not 100% sure of forming a limited company choose to go PAYE first and then switch if and when they decide it is absolutely for them.

It is good practice to find out what rate the agency /umbrella Company will pay you (and what your take home pay will be under each option) and it is also worth speaking with an accountant about the cost and what’s involved in running a limited company.