There are around 1.7 million contractors in the UK, many of whom operate as sole traders. A large proportion provide services exclusively (or primarily) to one client. A significant number of companies also try to convert a portion of their workforce from employees to contractors, often for tax avoidance purposes.
Key takeaways
- Contractors should consider forming limited companies to distance themselves from MSC legislation and clarify their employment status.
- Setting up a limited company is a quick process, often completed within hours through online registration.
- Contractors must diversify their client base to mitigate risks associated with IR35 rules and avoid disguised employment.
To counter this trend, the government has introduced various pieces of legislation over the years, aimed at preventing employers from classifying a member of staff as a contractor when, to all intents and purposes, they are an employee (known as ‘disguised employment’).
What is the difference between MSC legislation and IR35 rules?
The IR35 rules (also known as off-payroll working rules) came into force in 2000 and clamped down on the general practice of disguised employment. However, this did not prevent Managed Service Companies (MSCs) from continuing the practice of disguised employment (i.e. whereby an intermediary company, an MSC, essentially puts distance between the ‘employer’ and the ‘disguised employee’).
So the government decided to introduce MSC legislation in 2007, which deemed all payments received by a worker working through a MSC to be employment income.
Should a contractor set up a limited company?
Any freelancers and contractors who are concerned that they could fall under Management Service Company legislation (e.g. sole traders who work only for one client via a MSC), should consider setting up their own limited company. Doing so will normally be enough to establish themselves as falling outside the MSC legislation.
Please note: Setting up a limited company does not help to avoid IR35 rules. However, there are other measures which can be taken, e.g. taking on more clients and ensuring that any contract with the sole/primary client is not too restrictive (i.e. so it does not reflect an employment contract).
How can a contractor set up a limited company?
Setting up a limited company is very straightforward and can be completed in a matter of hours, particularly if it is done through a company formation agent such as Rapid Formations.*
Some of the decisions which need to be taken before registering a company with Companies House include:
- Choose a company name – there are various company name rules that must be followed when choosing a company name
- Choose director(s) – this can just be a single person (i.e. yourself)
- Choose shareholder(s) – this can just be a single person (i.e. yourself)
- Identify people with significant control (PSCs)
The process then involves incorporating the company with the Registrar of Companies – Companies House. It is possible to register a company online, either direct at Companies House or via a company formation agent like Rapid Formations.
Alternative methods include using third party software and applying to incorporate a company by post (these will require the use of Companies House form IN01).
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