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Do you need to set up a company if you are contracting in the UK?

Most of the IT contractors in the UK work through their own Limited Companies. Having you own company allows you to pay part of your salary as dividends, less taxed, and to claim business expenses.

However the British government has introduced the IR35 (Inland Revenue rule - UK tax / see FAQ) since the 2000 Budget and these tax advantages may have been removed depending on whether you fall within the new IR35 "rules" or not.

As a general rule, a Limited Company will be convenient if you are not concerned by the IR35 rule, and an Umbrella Company would probably be more beneficial otherwise.

Therefore you will have to choose between:

1/Setting up our own Limited Company
2/Using an Umbrella Company
3/PAYE (Pay As You Earn) through an agency


1. Setting up our own Limited Company

The majority of IT contractors work through their own Limited Company.

You can set up your own company from Companies House [http://www.companieshouse.gov.uk]. Even if it is relatively costless, you will have to complete the all forms and follow the process. Alternatively you can go for a faster solution: buy a Company name "off the shelf" or readymade using a Company formation service which enables you to complete the whole process on line within a matter of minutes. You will certainly have your brand new Company ready to trade within a few hours.

Whatever way you choose, you will have to appoint a secretary (usually a parent or partner). You will also probably need an accountant that will be able to do the financial work and calculate tax and N.I. contributions for you.

2. Using an Umbrella Company

An Umbrella Company will actually do the administrative work for you, issuing your client(s), collecting payments, calculate tax and N.I. contributions and of course transfering the money to you. In other words, the Umbrella Company provides a ready made invoicing vehicle for contractors, and removes the administrative duties normally associated with contracting.

You will pay their service every month (usually from £50 to £300 depending on the service). In the past, they where more expensive than setting up your own company as they were not offering the same tax advantage. However with the introduction of IR35 this disadvantage has been reduced.

Nowadays you will find plenty of Umbrella Companies on querying your favorite search engine.

3. PAYE through an agency

Some agencies allow you to become "PAYE" through their own payroll service. You lose the tax beneficial option available to a contractor as you pay full tax and national insurance (NI) contributions on all your earnings. And you are not allowed to claim valid business expenses. However it is hassle free as you are just a member of the staff - nothing to worry about the company.