Setting up as a self-employed person (i.e. becoming a sole trader) is the most hassle-free route to getting started in business. However, despite this, there are a number of compelling reasons why you’ll find it almost impossible to find recruitment agencies or clients who’ll engage you unless you work via a limited or umbrella company. Here we explain why.
Recruitment agencies will not hire sole traders
The Income Tax (Earnings and Pensions) Act 2003 does not allow self-employment when an agency is involved in the relationship between supplier and client. The reason being that your agency would be obliged to treat its sole trader contractors as ‘employees’ for tax purposes, and deduct income tax and National Insurance Contributions from your income, as this extract from Section 44 of the Act states:
“all remuneration receivable under or in consequence of the agency contract (including remuneration which the client pays or provides in relation to the services) is to be treated for income tax purposes as earnings from that employment.”
Despite the intentions of the parties, if you are hired as a sole trader, and subsequently deemed to be an ‘employee’ of the agency rather than a self employed individual, then you could in theory claim employment rights from the agency, and HMRC could even pursue the agency for any unpaid income tax and National Insurance Contributions (NICs).
These are the fundamental reasons why recruitment agencies will only deal with limited and umbrella companies, or sign you up as a PAYE employee from the start.
Limited company benefits
Aside from finding it very hard to secure contract work if you set up as a sole trader, there are numerous benefits to contracting via your own limited company.
Most importantly, becoming a limited company shareholder is the most tax-efficient way to contract, as you will usually draw down most of your income in the form or dividends, and not salary.
Dividends are not subject to NICs, whereas salaries are subject to both Employees’ and Employers’ NICs. The tax savings made by incorporating can be significant compared to going down the umbrella company route (assuming that your contract work is not caught by the IR35 rules).
Another important consideration is that your liability if anything goes wrong with the finances of your company is also limited, assuming that you have not acted illegally.
Sole traders are liable for all the debts and liabilities of their businesses and do not have the protection of a limited liability structure in case things go wrong.