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First Time Contractor - Deciding How to Start Contracting

As a contractor you can choose to operate in one of four ways:

  1. As an agency employee (PAYE)
  2. Become self employed (Sole Trader status)
  3. Work through an Umbrella Company
  4. Set up your own Limited company

Agency Employee (PAYE)

This is the easiest option for you to operate as a contractor because you are employed on the PAYE scheme through your agent’s payroll service. However, not all agencies offer this service.

It’s the ideal solution if you see contracting as a short-term option and want to see whether or not the lifestyle will suit you or perhaps you want a flexible career involving varied jobs. Many contractors choose this option because it suits their circumstances.

Self Employed (Sole Trader Status)

This is the simplest way for you to become your own boss but that means that any personal and business income will be treated as one entity for tax purposes and will be subject to Income Tax & National Insurance in much the same way as a permanent employee.

There a few concessions for allowable business expenses but from an accounting and taxation perspective this is not necessarily the most efficient way of working.

Umbrella Company

Working through an umbrella company essentially means that you are an employee of that company and they will take care of all your administration for you. This includes issuing invoices on your behalf, collecting payments and then paying you a net amount, less the umbrella company’s fees.

It’s the ideal solution if you do not want the hassle of running your own limited company or if you are looking to contract for short period of time.

You are also able to claim some basic expenses but you must ensure that they are HMRC compliant otherwise you could have future problems. Umbrella companies that say you do not need proof of receipts to claim expenses could be using a policy that is part of a tax avoidance scheme and should be avoided. If you are unsure contact us for professional advice and guidance.

Limited Company

This is the most common way for you to operate as a contractor and essentially you are the owner of your Limited Company (sometimes referred to by HMRC as Personal Service Company), appointing yourself as the director and shareholder.

However, the Limited Company is an entity in its own right which means that the company enters into contracts with a third party and not you as the contractor. It also means that the company has its own finances, therefore it’s responsible for its own debts if there are any.

Since you are able to claim a wide range of expenses operating as a limited company is one of the most tax efficient ways of working. To find out what expenses you can claim:

What’s the (financial) difference between a PAYE and Limited Company?

Using a sample of our existing clients we have summarised the potential effective tax rate advantages of operating through a limited company in comparison to PAYE, outside of IR35.

The effective tax rate represents the amount of tax and national insurance paid per £1 earned.

PAYE vs Ltd Co effective tax rate comparison

As you can see there are greater tax and national insurance savings to be had by operating through a limited company compared to PAYE.

If you have any further questions or want some advice please feel free to call us on 0203 368 3173 or email us at info@aidhanfinancial.com.

Aidhan Accountancy

Sutherland House, 3 Lloyds Avenue, London, EC3N 3DS