When first starting a business there are important decisions to be made relating to the legal standing of the enterprise. Whatever the type of business created all expenditure and earnings have to be properly accounted for and the correct records must be kept for taxation, VAT and National Insurance purposes. Sole traders, partners and contractors all have a legal responsibility to maintain those records. This can be quite an onerous task for someone that is running a small business. So, what is the best solution to reduce the burden and to ensure that all legal requirements are met and that annual tax returns are submitted to HMRC on time? This is where an umbrella company can be extremely useful. Another very important question that needs to be answered is what are the liabilities of individuals involved should a business fail? That is where the subject of limited companies comes to the fore.
What is a limited company?
Limited liability companies are formally registered at Companies House. A fee has to be paid to do this and a company secretary plus the company directors have to be named. Any shareholders in the business should also be declared upon registration.
To start a limited company a business bank account will need to be set up. An accountant is appointed to the business and provision will have to be made to cover legal issues such as professional indemnity and professional liability insurance. This is essential because a limited company is responsible for everything that it does as an entity, rather than any legal liabilities falling upon the shoulders of individual officers of the company.
A limited company must have a named secretary and at least one director responsible for running the company. The limited company can have a single director who is also the only shareholder. When the company is first formed it needs to declare its share capital and the names and addresses of all shareholders must be disclosed.
The greatest benefit of creating a limited company is that should the business be put into administration due to insolvency the director(s) will not lose his personal wealth or property to pay off the company’s debts. A director can also elect to take a monthly salary plus a dividend on the company profits at the year’s end. Limited companies also benefit from the flat rate VAT scheme. This was set up to simplify taxes for business. Again, the more a business earns, the greater the savings. The scheme works by providing some tax relief on VAT payments, so while a business can charge its customers 20%, it pays back at a lower rate.
A limited company can also make substantial savings by claiming tax allowance on a large range of costs, such as accountancy fees, equipment and software costs.
What is an umbrella company?
An umbrella company is an organisation that charges a fee to deal with all the administration for a sole trader, a contractor or small business that uses its services. Rather than a sole trader setting up a limited company, he or she can operate under an umbrella company that is usually run by a firm of accountants. The entrepreneur technically becomes an employee of the umbrella company.
The umbrella company is a legal framework that provides administrative expertise, cost savings and peace of mind for entrepreneurs and sole traders. The umbrella company will process invoices and pay the individual through the PAYE scheme. All available tax deductions will also be made to reduce the tax liability.
Typically, individuals take home around 60% to 80% of their gross income when working through an umbrella company. For many people the biggest benefit of using an umbrella company is that they totally avoid burdensome paperwork and the company deals with the annual return to Companies House and any dealings with HMRC.
Umbrella companies are not as tax efficient for higher earners but they are a fully managed business solution that can make day-to-day business much easier for entrepreneurs to run. Limited companies are more complex to set up and run for individuals, but the payoff is that there could be greater tax savings.
There is no reason why a contractor or entrepreneur cannot start out working under the umbrella company structure and then once established set up a limited company with in-house administrators. Most accountants will be happy to aid with the transition from using an umbrella company to being a private limited company. For those who wish to try their hand at running their own business using an umbrella company is often the easiest option until the business has grown to the point where all such administrative matters can be dealt with in-house.