Start Your Contractor Business: A Comprehensive Guide to Setting Up a Limited Company

Keen to start your own contracting business and leverage the rewards of being in complete control of your finances? Before launching your website and applying for contractor work, there are important business affairs to consider, namely what type of business structure you are going to work under.

For many small businesses starting out, the best option is to become a contractor limited company to help maximise income potential, as well as keeping the business outside of IR35 legislation, reducing tax liabilities. There are other business structure options, such as working under an umbrella company, however, you'll find the contractor limited company route is often a more tax-efficient path.

In this article, we provide a step-by-step guide to setting up your own contractor limited company and offer questions to ask yourself before you decide to venture out on your own.

Click a link below to jump to the section you're interested in:

• Choosing the Right Business Structure
• Setting Up a Limited Company for Contracting
• Best Practices for Success as an Independent Contractor

Choosing the Right Business Structure

There are many benefits of becoming a limited contractor company, however, it won't suit everyone. When deciding what business structure to opt for, think about your future business plans, financial affairs, the type of clients you want to work with, and your accounting capabilities. In this section, we look at the pros and cons of setting up your own limited company for contracting and how it differs from other business models.

What is a limited company?

In a limited company, the finances of the business are kept completely separate from the owner's finances, ensuring the owner's assets, like their home, are protected. As a limited company is a distinct legal entity, it is responsible for its own finances and debts, while the owners benefit from limited liability for any business debts, and are only liable for the amount they have invested in the company.

Alternatively, if you choose to operate as a sole trader, there is no legal separation between personal finances and business finances, therefore owners have unlimited liability on all business debts, thus putting personal assets at risk.

Why set up a limited company?

It is far more financially beneficial for you to work as a limited company contractor. Not only will you have complete control of your finances and bank account as the director and shareholder of your own business, but you can also dictate your own salary and dividend payments, in order to lower tax and national insurance contributions.

Differences Between Limited Companies and Umbrella Companies

Despite having total control of your business and its finances, going down the limited company route does come with legal obligations and management responsibilities, which can be challenging for owners. Working under an umbrella company, however, can be more straightforward when starting up a contractor company, as lots of administrative responsibilities, like invoicing and chasing payments, are done on your behalf, saving you stress and time.

With the umbrella model however, you're eligible for PAYE and NI contributions, as well as the services fees for the umbrella company, which can be up to 9% of the value of your contract. Creating a limited company has more tax advantages as you can pay yourself a smaller salary and then draw dividends that aren't subject to NI contributions, while you are also eligible to claim back a wider range of expenses, such as accountancy fees and software costs, allowing you to maximise your income. 

Advantages and Disadvantages of Operating as a Limited Company

The main advantage of operating your own limited company is that it is more tax-efficient than working under an umbrella company. As the director of your own limited company you have the ultimate control over the business affairs, and your liability if the company goes bankrupt is limited, unless, of course, you have been negligent or committed an offence. Another advantage is that a limited company is often viewed as more professional and credible than smaller businesses and large companies are more likely to want to deal with more established business structures. You’ll also look more favourable when seeking a bank loan. 

The main disadvantages of operating your own limited company are the responsibility, hassle and ongoing costs of running a business, although adopting digital management software can help alleviate many of these day-to-day stresses. You must also register your company every year with Companies House and file annual accounts with HMRC, however, hiring an accountant can reduce this cumbersome woe.

Common Misconceptions Dispelled

There are prevalent myths about limited companies that must be addressed, the most important being that 'setting up a limited company will help you avoid paying tax.' This is most certainly a myth. While a limited company is a more tax-efficient structure, you will still have to pay tax.

It is also a myth that as a limited company you must register for the VAT flat rate scheme. There is no legal obligation to register with HMRC unless the business's annual VAT taxable turnover exceeds £90,000.

Limited companies are not expensive to set up, despite thoughts of the contrary. The cost of running a limited company might indeed be higher than operating as a sole trader due to hiring the services of a contractor accountant to file annual accounts at Companies House. Having said that, it is recommended that all credible businesses keep their accounts in order, so this is an expense worth investing in.

Setting Up a Limited Company for Contracting

Arm yourself with everything you need to know thanks to this step-by-step guide to registering with Companies House:

Choosing a Company Name

Choose a unique business name that is distinct from you. It's advisable not to name the company after yourself as this could lead to HMRC treating you as an employee and making you subject to IR35 legislation. The name must also end with Limited or Ltd.

Company address

Your company address needs to be where you receive your official business post and be in the country where your company operates. If you don't have a dedicated workspace, you can use your home address.

Role of Company Director

The company director should be someone who is a good leader, decision maker, and competent with managing the day-to-day running of the business. They should also be savvy with the accounts and ensure corporation tax is paid on time, even if you are paying an accountant.

Decide on shareholdings

Unless you are the only director and therefore, sole shareholder, you may have more than one director of the company and each one may also be a shareholder. If so, it's crucial to clarify the number of shares each one owns so they know the percentage of the profits owed to them.

Register your company at Companies House

Once you have the above in place you can set up your limited company at Companies House by registering online for £12, which takes just 24 hours and registers you for corporation tax at the same time. Or you can sign up by post by completing form IN01. This can take up to 10 days and you'll need to register for corporation tax separately. Companies House will send you a certificate when completed.

Get a company bank account

As mentioned earlier, a limited company is a separate financial entity from your personal account, and therefore, will require its own business bank account. When you open a business account, your bank will require your Companies House registration number, and all the details of the directors, including their national insurance numbers.

Register for PAYE & NI (Pay As You Earn)

Anyone employed by your company is subject to PAYE & NI contributions on anything they earn from the company. The limited company must then let HMRC know each month of the PAYE & NI Contributions that are due. One way to limit the amount of income tax you owe is to pay yourself a low salary but take higher dividends.
Wondering what dividends are? These are a portion of the profits that are paid to the shareholders.

Register for VAT

You must register for VAT if your annual taxable sales are above £90,000 a year. If not, you can still register voluntarily if it makes sense for your business. VAT is a tax collected on behalf of HMRC, so when you register your limited company for VAT, you add VAT to your invoice and this gets directly paid to HMRC. It is never yours. You can also reclaim any VAT from the item you buy. The main advantage of registering for VAT is that it can help cash flow, and it can also make your business look more appealing to prospective clients, banks, and suppliers. It's easy to register online for VAT via the HMRC website and it usually takes 30 working days to receive your certificate.

Take out insurance

As you will be providing a service for a client, it's crucial to protect your business with insurance in case your advice or service results in loss for a client. Professional Indemnity Insurance is the most popular option for contractors, and it can help cover legal costs due to a breach of contract or negligence, as well as any compensation needed to be paid to rectify a mistake. Professional Indemnity Cover also demonstrates to HMRC that you are outside of IR35 legislation. Public liability insurance is crucial if you are carrying out work at a site belonging to your client, or you welcome visitors to your place of work, like a workshop or studio. It ensures you are covered for any legal or compensation costs should a member of the public get hurt at your place of work, or make a claim against your company.

Invoice your Clients and Keep a Record of Expenses

As a director of a contractor limited company, you will need to keep your financial affairs in order to maintain a steady cash flow. You will also need to file various mandatory accounts every year, as well as your tax return. These include accounts for your profit and loss and a director's report. Therefore, maintaining an orderly record of income and outgoings is vital.

What is IR35 Legislation?

If contracting industry legal jargon is giving you a headache, read this simple breakdown of IR35 legislation and get to grips with the essential information you need to know:

What is IR35 and how will it affect you as a contractor setting up limited company?

IR35 are rules that identify true self-employed contractors from disguised employees hidden behind a limited company, and whether you are inside or outside of the legislation. For more useful information, visit HMRC's official website to help identify where you stand with the legislation.

What does inside and outside IR35 mean?

If HMRC sees your services as inside IR35 legislation, where your relationship with your client is an employee-employer one, your income will be treated as PAYE and you lose the tax benefits of working within a contractor limited company. You are then taxed accordingly.

Suppose HMRC sees your services as outside IR35 legislation, where your relationship with your client is a supplier-customer one. In that case, you will benefit from the tax efficiency of a limited company.

What to do if you’re inside IR35?

You can either operate under an umbrella company, or you can still go down the limited company path. Although you wouldn't have the tax advantages of operating through a limited company, you would avoid paying an umbrella company's fees and you would retain control of your company bank account and affairs.

What to do if you’re outside IR35?

Establish a limited company to maximise your income. Most self-employed builders in the UK will choose this option as the typical take-home salary of limited company contractors is around 75-90% compared to those using an umbrella company, which will typically be 60-65%.

Best Practices for Success as an Independent Contractor

Once you've established yourself as an independent contractor, keep these long-term strategies in mind to ensure your small business flourishes and thrives:

• Keep your business and personal accounts separate, and maintain full financial records for budgeting and planning ahead. HMRC may contact you at any point to check your records, so keeping track of income and outgoings, such as business travel, mileage, and stationery, is essential. This will also help you accurately estimate your potential tax exemptions.
• Going digital with your accounts will help you stay on top of your finances. Houzz Pro's accounting integration easily syncs with Quickbooks Online or Xero, allowing you to sync every estimate and proposal, invoice, purchase order, and expense, so there's no more need for double data entry, saving you buckets of time.
• Hiring an accountant may be an option if you are unsure of your financial obligations and want to stay legally compliant. Shop around for the right accountant for you, instead of opting for the first one you find. Also, work out what you can do yourself, such as complete your self-assessment tax return, and you'll reduce your accountancy fees
• Adopt Houzz Pro software and impress your clients by running streamlined projects and delivering a standout customer experience using innovative management software.