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Tax Efficiency Comparison Umbrella Company vs Limited Company


Employment with Additional Contract Work

Umbrella Company vs Limited Company (Outside IR35)

1. Overview

This document provides a structured comparison of tax efficiency for an individual in stable employment who is considering additional contract work. The comparison evaluates engagement via an umbrella company versus operating through a limited company, where the contract work is assumed to be outside IR35.

The purpose of this document is to outline cost implications, tax treatment, and overall take-home pay considerations, supported by HMRC guidance and professional sources.

2. Scenario Assumptions

Category

Assumption

Primary income

Employment salary: £41,000 per annum

Additional income

Contract work: ~£387 per week (~£20,124 per annum)

IR35 status

Outside IR35

Limited company activity

Contract work and small home-based business

Working pattern

Contract income assumed to be ongoing

3. Option A – Employment Plus Umbrella Company

3.1 Income Composition

Source

Amount (£)

Salary

41,000

Umbrella contract income

~20,000

Total gross income

~61,000

3.2 Tax Treatment

  • All umbrella income is processed as PAYE employment income.

  • Income Tax and National Insurance Contributions (NICs) are deducted at source.

  • Umbrella company fees and employer NICs are effectively borne by the worker.

  • Business expenses cannot usually be claimed.

3.3 Key Characteristics

Advantages

  • Minimal administration.

  • PAYE compliance handled by the umbrella company.

  • Suitable for short-term or low-value contracts.

Disadvantages

  • Higher effective tax and NIC burden.

  • No flexibility over income extraction.

  • Weekly umbrella fees reduce take-home pay.

  • No expense deduction.

4. Option B – Limited Company (Salary and Dividends)

4.1 Operational Overview

A limited company is a separate legal entity. Where work is outside IR35, income can be taken in a tax-efficient mix of salary and dividends.

4.2 Typical Remuneration Structure

Item

Amount (£)

Contract income

~20,000

Salary

12,570 (personal allowance)

Remaining profits

~18,000 (before dividends & expenses)

  • Salary up to the personal allowance minimises Income Tax and NICs.

  • Dividends are taxed at lower rates than employment income.

  • Dividends are not subject to employee NICs.

4.3 Allowable Business Expenses

Examples include:

  • Accounting and bookkeeping fees

  • Software subscriptions (e.g. Xero)

  • Home office usage

  • Business insurance

  • Professional services

These expenses reduce taxable profit before Corporation Tax.

4.4 Advantages

  • Greater control over income timing and structure.

  • Lower overall tax burden for outside IR35 work.

  • Legitimate expense deductions.

  • No umbrella margin or hidden employer NIC deductions.

4.5 Considerations

  • Ongoing compliance with HMRC and Companies House.

  • Annual accounts and tax returns required.

  • Professional accountancy support strongly recommended.

5. Umbrella Company – Weekly Cost Breakdown (Illustrative)

Cost Type

£

Description

Employer NI

21.34

Employer NICs passed to worker

Employer pension

3.55

Deducted from assignment rate

Apprenticeship levy

1.19

Government levy

Umbrella margin

23.00

Weekly payroll fee

Salary sacrifice NI saving

0.89

Structural deduction

Expenses (non-taxable)

92.85

No reimbursement benefit

6. Limited Company – Annual Costs

Item

Cost (£)

Frequency

Bookkeeping

720

Annual

Xero subscription

444

Annual

Company formation

250

One-off

Accountant fees

850

Annual

Bank & insurance

240

Annual

Total annual cost

2,504


7. Umbrella Company – Annual Costs

Item

Cost (£)

Weekly umbrella fee (£50 × 52)

2,600

Expense deductions

0

Total annual cost

2,600 + full PAYE/NICs

8. Summary Comparison

Structure

Annual Fees (£)

Key Notes

Limited company

2,504

Expense deductions, dividend flexibility

Umbrella company

2,600+

Simpler but higher effective tax

Key Observations

  • Limited company costs are lower on fees alone.

  • Expense deductions further improve tax efficiency.

  • Umbrella arrangements result in higher tax and less control.

  • For meaningful outside IR35 income, a limited company generally provides higher net take-home pay.


9. HMRC and Legal Overview

Umbrella Companies

  • Umbrella companies must operate PAYE.

  • Workers should avoid schemes promising excessive tax savings.

  • New PAYE supply chain rules apply from 6 April 2026.

Limited Companies

  • Must comply with Corporation Tax, dividend reporting, and statutory filings.

  • Dividends are taxed separately from PAYE income.

  • HMRC permits expense deductions where wholly and exclusively for business.

10. Professional & HMRC Reference Links

 
 
 

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