Go Limited - April - Advantages and Disadvantages of Setting Up a Limited Company Under IR35
Go Limited - April - Advantages and Disadvantages of Setting Up a Limited Company Under IR35
There's a lot of freedom that comes with contracting in the UK, giving you the chance to work flexibility, potentially boost your income and be your own boss. But, there's also a lot of decisions that come with contracting, especially when it comes to determining how you structure your approach to work. For many contractors, this means deciding whether or not to set up a limited company.
The decision of whether to set up a limited company for contracting is closely linked to IR35, a piece of legislation that affects how you're taxed. Whether you're considered an employee or self-employed impacts how much you're taxed and how much of your earnings you keep, and whether you fall inside or outside IR35 is the determining factor. For some contractors, setting up a limited company is the obvious choice, but it's slightly more nuanced for others.
At Go Limited, we've taken a look at what setting up a limited company means depending on if you're working under IR35 and whether going limited is the right choice for you.
IR35 Through a Limited Company: What Does it Mean?
IR35, also known as the off-payroll rules, was introduced by HMRC to tackle tax avoidance. Many people supply their services via a limited company benefiting from the tax-efficiency of being a contractor, but there's a select group who would be considered employees if the limited company didn't exist, who could be avoiding paying the right amount of tax. In the eyes of HMRC, they should be treated as employees for tax purposes, and not benefit in the same way that other contractors do.
If you're working as an employee - for example, if you're taking direction from a manager, using equipment provided by a client and working set, pre-agreed hours - then HMRC are likely to view you as being inside IR35, even if you're invoicing as a business. This means that you are an employee, and should therefore be treated as an employee when it comes to paying tax.
If your contract is outside IR35, you're considered self-employed and have the freedom to operate more tax efficiently.
Inside IR35 vs. Outside IR35 as a Limited Company Contractor
Whether or not you're working inside or outside IR35 doesn't usually change the day-to-day of your job, but it does change how much income tax and National Insurance (NICs) you pay. This means that setting up a limited company benefits a lot of contractors, but not if your contract is inside IR35, as you'll be treated as an employee for tax purposes.
When working through your own limited company, you become a director and shareholder of your own business. You're responsible for paying corporation tax, filing accounts, managing payroll - for yourself and anyone you employ - and ensuring tax compliance. This adds a lot of administrative responsibility to your plate, and it's only usually worth it if your contracts are outside IR35.
- Inside IR35 - You must pay income tax and NICs as if you were employed by your client. The financial benefit of running your own company becomes minimal, but the admin responsibility remains the same.
- Outside IR35 - You can draw a small salary and top up your income with dividends, which are taxed at a lower rate. This allows for more control and often a higher take-home pay, making setting up a limited company worthwhile and financially beneficial.
The Pros and Cons of Setting Up a Limited Company Under IR35
When it comes to setting up a limited company for contracting, there are a handful of pros and cons to be aware of, many of which are linked to IR35.
The Advantages of Setting Up a Limited Company Under IR35
- When you set up a limited company and your contracts are outside IR35, you have greater control and flexibility over how, when and where you work. You are your own boss, working as a truly self-employed individual.
- You also have the potential to enjoy higher take-home pay. If you're working outside IR35, you can benefit from taking your earnings as a combination of salary and dividends, lowering your taxable income.
- Contractors with a limited company can claim business expenses, which further reduces your taxable income. This includes costs such as travel, office costs, accountancy and equipment. If an expense is wholly and exclusively for the benefit of your business, you can usually claimit as an expense. This isn't possible if you're working inside IR35.
- Setting up a limited company gives you a stronger professional image, which appeals to a lot of clients. Many larger businesses prefer to work with limited companies, which helps you to stand out from other freelancers and contractors.
The Disadvantages of Setting Up a Limited Company Under IR35
- One of the biggest downsides of setting up a limited company is the risk of getting your IR35 classification wrong, and therefore not complying with the regulations set out by HMRC. Distinguishing between inside and outside IR35 can be complex and there's a chance you could get things wrong, resulting in you paying too little tax. This is why a lot of contractors enlist the help of a limited company accountant.
- There are administrative responsibilities that come with being a limited company contractor, as well as accountancy costs if you choose to hand those responsibilities over to an expert. However, for a lot of contractors, the tax-efficiency and increased take-home pay more than balances things out.
- If your contracts fall inside IR35, there are fewer benefits to setting up a limited company. You don't benefit from business expenses, tax-efficiency or higher take-home pay. This is why setting up a limited company tends to be better suited to those with contracts outside IR35.
Understanding IR35: Umbrella vs. Limited
There are two main ways of navigating contracting and IR35, and that's setting up a limited company or working with an umbrella company. When you set up an umbrella company, you are the director and you run the business. You're responsible for managing invoicing, tax, accounts and payments, and you can pay yourself via salary and dividends. But, you're also required to stay on top of IR35 and ensure that you're always classifying yourself in the right way. If you make a mistake, you could face penalties. A limited company is usually best for contractors with long term plans, who can secure outside IR35 contracts and want maximum control.
The other option is to work with an umbrella company, which makes you an employee of that umbrella company. This is a simpler way of navigating contracting, as they handle invoicing, payroll and tax deductions for you. You pay income tax and NICs through PAYE, which is simpler, but also means you can't pay yourself in a tax efficient way or claim allowable expenses. You also have to pay a fee to the umbrella company, which can eat into your profits.
Working with an umbrella company is best for contractors on short-term contracts, inside IR35 roles or those who prefer less admin.
Should You Set Up a Limited Company for Contracting?
Deciding whether to set up a limited company as a contractor comes down to your individual circumstances, and there's no 'one size fits all' answer. If your contracts are mostly outside IR35, if you plan to contract for the foreseeable future and you're comfortable managing your business finances (or working closely with an accountant who's been instructed to handle things on your behalf) then setting up a limited company can be a smart and financially rewarding move. It offers you more control over your income, the ability to make tax-efficient decisions, and the freedom to operate your business in a way that suits you.
But, if most of your work is inside IR35, or if you're only planning to contract for a short period of time, the benefits of running your own company dwindle. For a lot of contractors in this situation, the admin, tax responsibilities and potential exposure to IR35 liabilities outweigh the financial advantages, making it easier to work with an umbrella company. For those looking for a simple way of working, or those working in sectors where inside IR35 contracts are the norm, an umbrella company could be a better approach.
When it comes to setting up a limited company, or choosing to work with an umbrella company, the key is to assess your situation carefully. You need to do this not just from a financial perspective, but also in terms of how much responsibility you're willing to take on, how long you plan to contract for, and what kind of work contracts you're likely to secure. This can feel daunting at first, but Go Limited is here to help. With our guidance, you can choose an approach to contracting that works best with your career and financial goals.
FAQs: Limited Companies and IR35 – What UK Contractors Need to Know
1. What is IR35 and why does it matter if I'm contracting through a limited company?
IR35 (also known as the off-payroll working rules) determines whether you're genuinely self-employed or effectively an employee for tax purposes. If you're 'inside IR35', HMRC will tax you like an employee — meaning fewer financial benefits from using a limited company.
2. Can I still use a limited company if my contracts are inside IR35?
Yes, you can. However, if you're inside IR35, most of your income will be taxed via PAYE, and the admin burden of running a limited company may outweigh the benefits. Many contractors in this position consider using an umbrella company instead.
3. What are the main advantages of setting up a limited company outside IR35?
If you're outside IR35, you can:
- Take advantage of tax-efficient income via salary and dividends
- Claim allowable business expenses
- Retain more control over your finances and working practices
- Present a more professional image to clients
4. What are the downsides of using a limited company if I'm inside IR35?
You'll face the same administrative and compliance responsibilities, but without the same tax efficiency. You can't claim many expenses, and most of your income will be taxed at standard employee rates.
5. What kind of expenses can I claim if I'm outside IR35?
If you're operating outside IR35, you can claim costs such as travel, equipment, software, accountancy services, and other expenses that are wholly and exclusively for your business.
6. How do I know if my contract is inside or outside IR35?
This depends on the actual working practices, not just what the contract says. Factors include control over your work, whether you can send a substitute, and how integrated you are with the client's team. You can use HMRC's CEST tool or seek expert advice to help determine your status.
7. Should I use an umbrella company instead of setting up a limited company?
Umbrella companies are ideal for contractors working inside IR35 or on short-term contracts. They manage your tax, payroll, and admin — but you'll usually have a lower take-home pay and pay a weekly or monthly fee.
8. Is a limited company worth it if I plan to contract long-term?
If your work is mostly outside IR35 and you plan to contract for the foreseeable future, a limited company often gives you greater financial rewards and flexibility. Just be prepared to handle (or outsource) the admin and stay compliant.
9. What happens if I get my IR35 status wrong?
If HMRC decides you've incorrectly assessed your IR35 status, you could face backdated tax bills, interest, and penalties. That's why many contractors work with specialist accountants or IR35 advisors to stay on the right side of the rules.
10. Can Go Limited help me decide what structure is best for my situation?
Absolutely. At Go Limited, we're here to help you assess your contracts, understand IR35, and choose the most tax-efficient and practical option — whether that's setting up a limited company or working through an umbrella.
Important:
Please note: Any rates and thresholds mentioned in this article are correct at the time of publishing and may be subject to change.
When choosing an accountant, look for one with proven experience and expertise in the contracting sector, particularly around areas like IR35, limited company tax matters and off-payroll working. Formal qualifications are important, but relevant hands-on knowledge matters just as much — especially in a complex and fast-changing landscape like this.
