PAYE vs Limited Company

Here at Parasol, we’re often asked by the contractors we support about the difference between working PAYE and through a limited company and, more specifically, if one is better than the other.

To help you understand the difference between the two, so you can make an informed decision about how you’d like to work as a contractor, we’ve answered the key questions relating to PAYE vs LTD below.

What is PAYE?

PAYE stands for ‘Pay As You Earn’, in reference to how your income is taxed.

This method means you’ll pay tax on your salary throughout the tax year, as opposed to via the self assessment tax return, which self-employed people file once a year.

Under PAYE, your employer will deduct the appropriate Income Tax and National Insurance contributions from your pay/salary, and pay this over to the HMRC on your behalf. They will then issue you with a payslip, which will detail the amount of tax you’ve paid for that period.

PAYE workers are recognised as employees, not self-employed.

What is ‘LTD’?

If someone talks about working ‘limited’ or ‘LTD’, it’s likely that they mean operating via their own limited company.

This business structure suits lots of contractors (and is popular among those operating ‘outside IR35’) who provide their services to clients through limited companies, which are also known as ‘personal service companies’.

Contractors who work through their own limited companies can choose to pay themselves in a variety of ways, and so can take advantage of legitimate tax efficiencies. This may be a combination of a smaller regular salary, and topped up with dividends from the profit of the company.

Unlike PAYE employees who are taxed on all of their pay as they earn it, irrelevant of whether they use or need all of the monies in the year, Ltd company workers can choose when to take their monies from the company, and they are only taxed personally on the money which is withdrawn from the company in a tax year. Anything they leave in the company as profit, or reserves, will just roll over to be taken in future periods. When working via a limited company (and not under PAYE), contractors pay personal tax through the self-assessment tax return. This is in addition to corporation tax, which is paid by their business on profits declared.

Can I be PAYE and have a limited company?

Yes. Contractors can pay tax via PAYE and work through their own limited company. However, since the IR35 reforms, the options of how you can work on an inside IR35 assignment may be dictated by the agency you are working with, and who will advise on how they are willing to work with you, as they are responsible for ensuring that the correct tax and NI deductions are made from your pay.

For example, a contractor working inside IR35 pays tax under the PAYE system, with the fee-paying party deducting the appropriate taxes and paying this to HMRC - unless the contractor is engaged by a small business, which means they are responsible for making the deemed payment at the end of each tax year.

And while contractors working inside IR35 aren’t classed as employees, they are considered ‘employed for tax purposes’. However, despite paying PAYE tax, they don’t receive employment rights such as sick payholiday pay and paid maternity or paternity leave.

If your agency does not have its own payroll arrangements, it may require you to work through an umbrella company on any inside IR35 assignments, so that they can be confident that the correct deductions are made to the HMRC. As IR35 legislation covers each assignment worked on however, a contractor may find one contract inside IR35, and the next outside the legislation, and so they may alternate between working via an umbrella company and their own limited company.

While the tax implications of working inside IR35 (under PAYE) and through an umbrella company are broadly the same, there is a key difference - umbrella workers qualify for employment rights.

Learn more about the advantages of working through an umbrella company.

Tax implications of PAYE vs LTD

So what’s the difference in take home pay when working via PAYE or through a limited company and outside of IR35?

Many factors determine someone’s tax liability, such as how much they earn in a year, their personal tax code, pension contributions, expenses claimed, and other scenarios, which means for those who’s day-to-day job isn’t accountancy, it can be difficult to forecast a direct comparison between the two ways of working.

Under PAYE, contractors are taxed as employees, while those operating via their limited company (and outside IR35), contractors tend to pay personal tax through the self-assessment tax return.

PAYE employees pay both income tax and NI contributions based on all of the income that they earn in a tax year.

In contrast, working through a limited company means that you can take advantage of tax efficient strategies, such as setting salary at a level which incurs no NI contributions, and yet still gives you qualifying payments towards state pensions and benefits, and also company tax relief. The remainder of the income is then topped up by drawing dividends from the company profit.

Taking dividends not only means that you can choose when to take your money, and so put some great tax planning in place, but dividends are also taxed at a lower rate than PAYE income tax.

Limited company vs PAYE - other key differences

Tax aside, there are several other contrasting features to PAYE and limited. Working on the basis that a contractor is operating outside IR35 (not under PAYE), these include:

Feature PAYE Limited Company (LTD)
Employment rights Statutory employment rights are granted to employees (and umbrella workers) Do not receive employment rights from end-clients
Business expenses Received by umbrella workers, but not employees Can claim a wider range of business expenses
Administration No administrative tasks and PAYE workers can focus on the job in hand There are a number of tax, accounting and company filing responsibilities
IR35 Does not apply to PAYE workers, who are either employed or employed for tax purposes Is a major consideration for limited company contractors

PAYE vs LTD - which is best?

The debate over PAYE vs limited is never-ending and in truth, there is no clear winner. It’s a case of weighing up which one suits your short and long term requirements and often, the nature of the project that you’re working on.

Find out more

For more information and to hear how working through an umbrella company - and under PAYE - could meet your needs, please speak to one of our experts.

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