Setting Up a Limited Company for Contracting UK – Step By Step Guide

Introduction

In today’s fast-moving contractor market, flexibility, tax efficiency, and professional standing are critical. Whether you work in IT, engineering, finance, healthcare, or creative industries, many UK professionals find setting up a limited company provides significant advantages over traditional employment or umbrella companies.

Operating your own limited company gives you control over your income, allows for smarter tax planning, and presents a more professional image to clients and agencies. However, it also requires understanding key responsibilities, legal requirements, and financial management best practices.

This comprehensive guide will walk you through the full process of setting up a limited company for contracting in the UK – with real-world examples, expert tips, and essential warnings.

What Are the Benefits of Setting Up a Limited Company for Contracting UK?

• Maximized Take-Home Pay: Contractors can split their income between a low salary and dividends, reducing the amount of Income Tax and National Insurance Contributions (NICs) paid.
• Enhanced Professional Image: Clients and recruitment agencies often prefer working with limited companies, seeing them as more serious, stable, and professional. Registering a business domain, setting up a branded email address, and using proper invoicing systems significantly improve how clients perceive you, making you more competitive.
• Complete Financial Control: You decide when and how to distribute profits, when to reinvest, and which expenses to claim. Allowable expenses may include travel to client sites, home office utilities, subscriptions to professional bodies (like CIPD or BCS), and essential equipment such as laptops or software. Keeping detailed records can also help reduce your Corporation Tax liability.
• Future Growth and Scalability: Starting solo doesn’t limit your growth potential. You can eventually hire employees, subcontract work, or expand into new service lines. For instance, Sarah, a freelance project manager, started with just herself and a laptop. Within five years, she employed six consultants and was winning major corporate contracts—all made possible with a limited company structure.

How Do You Decide If Setting Up a Limited Company Is Right for You?

Deciding whether setting up a limited company is right for you depends on several important factors. It’s essential to weigh these carefully to ensure the structure aligns with your income goals, lifestyle, and long-term contracting plans.

1. Expected Income Level

One of the key considerations is your expected annual income. Generally, if you expect to earn more than £50,000 per year, setting up a limited company becomes more financially advantageous compared to working under an umbrella company. The tax savings through the salary-dividend split and claiming allowable business expenses can significantly increase your take-home pay.

However, if your income is lower or if you’re contracting for a short period, the administrative burden and accounting costs may outweigh the benefits.

2. IR35 Status Assessment

Understanding your IR35 status is crucial. If your contracts fall outside IR35 legislation, you can enjoy the full tax efficiencies of operating through a limited company. However, if you are caught inside IR35, you would be taxed similarly to a permanent employee, reducing many of the advantages.

3. Contract Length and Future Plans

If you are planning to contract long-term or foresee a steady flow of assignments, running a limited company provides maximum flexibility and financial benefits. It allows you to build a personal brand, maintain multiple client relationships, and scale your operations if needed.

Conversely, if you’re taking on a short-term role (less than six months) or are unsure about committing to contracting long-term, an umbrella company might be more appropriate to avoid setup and closure costs.

4. Administrative Responsibility

Running a limited company involves ongoing responsibilities like submitting annual accounts, VAT returns, Corporation Tax filings, and maintaining payroll.

If you’re organised or willing to hire a specialist contractor accountant, these tasks become manageable. However, if you prefer to focus solely on project work without handling business administration, an umbrella company might be a better fit.

5. Desire for Full Financial Control

With a limited company, you have complete control over:

• How much salary to pay yourself
• When and how to declare dividends
• Managing and reinvesting business profits

This flexibility empowers you to optimise your finances, but also places the responsibility on you to comply with legal and tax obligations.

What Are the Key Steps in Setting Up a Limited Company for Contracting UK?

Starting your limited company journey requires following clear and structured steps.

Here’s a complete walkthrough:

Step 1: Choose an Appropriate Company Name

Choosing the right company name is crucial because it becomes part of your brand identity. Your name has to be unique and not overly similar to that of other businesses that are already listed with Companies House.

Tips for Naming Your Company:

• For availability, see the Companies House record.
• Avoid sensitive or restricted words without permission.
• Try to get a matching domain name for your website.

Choosing a professional and memorable name helps you stand out when dealing with agencies and clients.

Step 2: Prepare Key Company Documents

The following paperwork is required to form your limited company:

• Memorandum of Association: A formal document that all original shareholders signed, committing them to the formation of the firm.
• Articles of Association: Rules for running your company, covering decision-making, shareholder rights, and management processes.
• A director and a shareholder Details: You have to assign at least one share and designate at least one director.

Pro Tip: For simple setups, standard templates provided by Companies House are sufficient.

Step 3: Register with Companies House

Once your name and documents are ready, register your company either directly through Companies House or via a formation agent.

Registration Details:

• Online registration fee: £50
• Postal registration fee: £71
• Processing time: 24 hours for online applications, longer by post

A Certificate of Incorporation attesting to the legal existence of your business will be issued to you upon approval.

Step 4: Create a Bank Account

Creating a specific business bank account helps you stay on top of your money and keeps your transactions and business operations apart.

Required Documents:

• Certificate of Incorporation
• Memorandum and Articles of Association
• Evidence of the firm director or directors’ identification and address

Several banks offer free banking periods for new businesses, usually between 12-24 months.

Step 5: Register for Corporation Tax

You have to register your business with HMRC for Corporation Tax within three months of beginning to trade. You will need your company registration number, the start date of business activities, and details of your accounting period.

Common Mistakes to Avoid: HMRC may impose fines for late registration.

Step 6: Consider VAT Registration

If your yearly turnover exceeds £90,000, you must register for VAT. To enhance your professional image and recover VAT on business expenditures, you can also decide to voluntarily register.

Step 7: Set Up a Payroll System (PAYE)

Even as the sole director, if you plan to draw a salary, you must set up a PAYE system to manage salary payments and National Insurance Contributions. Software like FreeAgent, QuickBooks, or Xero can integrate payroll with your overall accounting to simplify compliance.

Pro Tip: Most contractor accountants include PAYE setup and ongoing payroll submissions as part of their service packages.

What Does It Cost to Set Up a Limited Company UK?

Understanding the full financial commitment involved in setting up and running a limited company helps you budget more accurately. While the setup costs are relatively low, it’s important to factor in ongoing business expenses to avoid surprises.

Below is a breakdown of typical one-time and recurring costs associated with operating a limited company in the UK:

Cost Item	Description	Estimated Cost
Companies House Registration	Online registration via gov.uk	£50
Postal Company Registration	Optional paper-based application	£71
Formation Agent (Optional)	Bundle including setup, registered office address	£50–£200
Business Bank Account	Monthly fee after initial free period	£6–£10/month
Contractor Accountant	Monthly fee for full service incl. PAYE, VAT, returns	£80–£150+/month
Accounting Software	Tools like FreeAgent, QuickBooks, Xero	£10–£30/month
Business Insurance	Professional indemnity, public liability, cyber cover	£200–£700+/year
Website & Email Domain	Hosting, domain, branded email	~£50/year
Miscellaneous Setup Costs	Office supplies, business cards, marketing	Varies

Tip: Most of these costs are allowable business expenses, which means they are tax-deductible.

What Financial Obligations Come with Setting Up a Limited Company?

Once your limited company is up and running, it’s essential to stay on top of the financial responsibilities required by HMRC and Companies House. These obligations ensure your business remains compliant with UK tax and company law.

1. Corporation Tax

Corporation tax applies to all of your business’s taxable profits. This includes income from trading, investments, and asset sales. The current rate (as of 2024) is 25% for companies with profits over £50,000.

• Every year, you have to submit a Company Tax Return (CT600).
• Taxes are due nine months and one day after the end of your accounting period.

Plan by reserving around 20–25% of your profits in a separate tax account.

2. Value Added Tax (VAT)

If your annual turnover exceeds £90,000, you are required to register for VAT. Even below this threshold, voluntary registration may be beneficial if you work with VAT-registered clients.

• Submit VAT returns quarterly.
• The difference between the VAT charged and the VAT recovered should be paid to HMRC.
• The Flat Rate VAT Scheme simplifies reporting for many contractors.

3. PAYE and National Insurance

If you pay yourself (or others) a salary, you must operate a PAYE payroll system:

• Use Real Time Information (RTI) to submit salary reports to HMRC.
• Each month, deduct and pay income tax and NICs.
• Submit annual payroll reports and summaries (P60, P11D).

4. Dividend Tax

Dividends are taxed separately from salary. As of 2024:

• Dividend income up to £1,000 is tax-free.
• Basic rate: 8.75%
• Higher rate: 33.75%
• Additional rate: 39.35%

5. Annual Accounts and Confirmation Statement

You must submit:

• Using UK accounting standards, annual reports are created and submitted to Companies House.
• Confirmation Statement (previously Annual Return) to confirm company details once a year.

Fines or even the liquidation of the business may follow late submissions.

6. Record Keeping

Keep all business records, including:

• Invoices, receipts, and bank statements
• Payroll and pension records
• Copies of submitted tax returns

These need to be kept in a safe place for at least 6 years.

How Does IR35 Affect Contractors with Limited Companies?

It is essential for contractors working via limited firms to comprehend IR35 regulations. The off-payroll working regulations, or IR35, establish whether you are truly self-employed or if you should be taxed as an employee under a certain contract.

What is IR35?

The purpose of IR35 is to prevent tax evasion by workers who provide services through a limited company or other intermediary but would still be regarded as employees in the absence of that intermediary.

If your contract and working practices suggest that you are effectively an employee, you will be considered ‘inside IR35.’ If you operate as a genuine business, you are considered ‘outside IR35.’

Why IR35 Status Matters

• Inside IR35: Just like an employee, you are required to pay income tax and national insurance contributions. As a result, the tax benefits of using a limited corporation are greatly diminished.
• Outside IR35: You can continue to benefit from the tax efficiencies offered by dividend payments and business expense claims.

The financial implications of being inside IR35 can be severe, potentially reducing your net income by up to 25%-30%.

How IR35 is Determined

When assessing IR35 status, a number of variables are taken into account, such as:

• Control: Is the customer in charge of where, when, and how you operate?
• Substitution: Are you allowed to send someone else to complete the work?
• Mutuality of Obligation (MOO): Is there an expectation that work will be offered and accepted?

Other factors like equipment ownership, financial risk, and business presence (website, business insurance) can also influence status.

Who Decides IR35 Status?

• Public Sector Contracts: Your IR35 status is decided by the final customer.
• Private Sector Contracts (Medium/Large Businesses): Your IR35 status is also decided by the final customer.
• Private sector small company contracts: the contractor determines the IR35 classification.

Your working processes should be in accordance with your intended IR35 status, and you should always seek a competent contract review. Always seek a professional contract review and ensure your working practices align with your intended IR35 status.

Managing IR35 Risks

• Employ Business-to-Business Contracts That Are Clear: Steer clear of employee-like terminology.
• To be financially independent, make investments in branding, marketing, and a large clientele.
• Obtain IR35 Insurance to guard against the expenses of an HMRC probe.

What Are the Ongoing Compliance Requirements After Setting Up a Limited Company?

Running a limited company isn’t a one-off administrative task; it requires ongoing attention to various compliance duties to ensure that your business remains legally active, financially healthy, and fully compliant with UK regulations. Failure to meet these obligations can result in financial penalties, reputational damage, or even dissolution of your company.

Filing Annual Accounts

At the conclusion of every fiscal year, your company is required to prepare and submit annual accounts to Companies House. These accounts must accurately reflect your business activities, including your:

• Turnover (total revenue)
• Expenses
• Assets owned
• Liabilities owed
• Profit or loss figures

Deadlines:

• After your accounting period ends, you have nine months to file your accounts.
• Legally, inactive accounts must be filed by even dormant businesses.
• Filing late can result in penalties starting from £150 and increasing significantly based on how overdue the accounts are.

Filing a Confirmation Statement

The Confirmation Statement (previously called the Annual Return) updates Companies House with key information about your company, such as:

• Company name and registration number
• Registered office address
• Directors and secretary details
• Shareholders and statement of capital
• SIC (Standard Industrial Classification) codes indicating your business activity

Important:

• At least once every 12 months, it must be submitted.
• Even if nothing has changed, you must confirm the details.

Submitting Corporation Tax Returns

You must file a Corporation Tax Return (CT600) to HMRC each year, regardless of whether you earn a profit. This shows how much Corporation Tax your company owes based on its profits.

• 12 months after the end of your accounting period is the filing deadline.
• 9 months and one day following the conclusion of your accounting period is the payment deadline.

You must keep detailed records that back up the figures you report.

Tip: Reserve a percentage of your profits (typically 20%-25%) throughout the year to cover your Corporation Tax liability and avoid any cashflow surprises.

Managing Payroll and PAYE

If you pay yourself a salary, even as the sole employee, you must:

• Register as an employer with HMRC.
• Operate a PAYE scheme.
• Submit monthly Full Payment Submissions (FPS) via Real Time Information (RTI).
• Issue payslips.
• Complete end-of-year reports like P60s and P11Ds (if applicable).

If you employ others, you must also manage pension auto-enrolment responsibilities.

Submitting VAT Returns (If Applicable)

If your business is registered for VAT, you must:

• Typically, every quarter, submit VAT returns to HMRC.
• By the specified time, pay any VAT that is due.
• Keep invoices and VAT records for a minimum of six years.

Many contractors opt for the Flat Rate VAT Scheme for simplicity, although eligibility and profitability under this scheme should be reviewed annually.

Keeping Business Records

Good record-keeping is not only a legal requirement but essential for efficient company management and defence in the event of an HMRC investigation.

You should securely store:

• Sales and purchase invoices
• Bank statements and transaction histories
• Expense receipts
• Payroll records
• VAT records

Retention Period: At least 6 years after the accounting period they relate to.

Common Mistake to Avoid: Relying solely on bank statements for record-keeping. Always keep supporting invoices and receipts.

Meeting Deadlines

Running a limited company means juggling multiple deadlines for:

• Annual accounts
• Corporation Tax Return
• PAYE reporting
• VAT submissions
• Confirmation Statement filing

Consequences of Missing Deadlines:

• Late filing penalties start from £150 and escalate rapidly.
• Damage to the company’s credit score.
• Risk of HMRC inquiries and Companies House action.

How Can You Close Your Limited Company If You Stop Contracting?

At some point, you may decide to stop contracting, retire, or move into permanent employment. If so, you need to close your limited company properly to avoid ongoing tax and compliance obligations.

Two ways to close a limited company:

1. Voluntary Strike-Off (Dissolution)

A voluntary strike-off is the easiest and most cost-effective way to dissolve a limited company, provided certain conditions are followed.

When to Use:

• It has been at least three months since your firm last traded or conducted any business.
• Your company has no outstanding debts.
• Your company has no ongoing legal proceedings.

Key Steps:

• Settle all company debts and liabilities.
• Distribute any remaining assets to shareholders.
• Close your business bank account.
• Give HMRC your final accounts and corporation tax return.
• Send a DS01 form and the necessary £10 fee to Companies House.

 Important Note: You have seven days to notify all parties involved (such as creditors, employees, and shareholders) before completing a DS01 form.

2. Members’ Voluntary Liquidation (MVL)

The most tax-efficient option would be a Members’ Voluntary Liquidation if your business has assets or retained earnings above £25,000.

When to Use:

• The business can pay off its obligations since it is solvent.
• Significant cash or assets remain within the business.

Benefits of MVL:

• Instead of being recognized as income, distributions to shareholders are considered as capital.
• Qualified for Entrepreneurs’ Relief (formerly known as Business Asset Disposal Relief), which lowers capital gains tax to 10%.

Key Steps:

• Appoint a licensed insolvency practitioner.
• Complete a Declaration of Solvency.
• Proceeds from asset sales are distributed to shareholders.
• Officially dissolve the company after clearance.

Costs: MVL procedures typically cost between £2,000 to £5,000, but the tax savings can significantly outweigh the fees if substantial funds are involved.

Common Mistakes to Avoid When Setting Up and Running a Limited Company

While running a limited company offers numerous benefits, mistakes can be costly. Being aware of common pitfalls helps you avoid them and operate more effectively.

1. Ignoring IR35

Inaccurately determining your IR35 status may lead to large, unforeseen tax obligations. Always review contracts and working practices carefully.

2. Mixing Personal and Business Finances

Using the same bank account for personal and company transactions can create accounting chaos and invite HMRC scrutiny. Always maintain separate business accounts.

3. Missing Compliance Deadlines

Late filing of accounts, VAT returns, or Confirmation Statements leads to penalties and damages your company’s reputation.

4. Poor Record Keeping

Losing invoices, not tracking expenses, or failing to record dividends properly can result in higher tax bills and problems during HMRC investigations.

5. Underestimating Admin Responsibilities

Running a limited company requires organisation. Many contractors underestimate the ongoing compliance burden. Partnering with a contractor-specialist accountant simplifies this and keeps you focused on your work.

6. Incorrectly Closing a Company

Striking off without settling outstanding Corporation Tax, PAYE, or VAT obligations can cause serious issues later. Always close your company properly through HMRC and Companies House procedures.

Tip: Regularly review your compliance checklist or have your accountant provide quarterly health checks.

Conclusion

Is Setting Up a Limited Company for Contracting the Right Move for You? It’s one of the most effective ways to maximize your income, maintain control over your business activities, and present a highly professional image to clients and agencies. For many contractors earning over £50,000 per year, a limited company structure offers unparalleled tax efficiencies and flexibility compared to umbrella companies or sole trader setups.

However, this route is not without its responsibilities. Contractors must manage their financial and compliance duties carefully, understand their IR35 obligations, and maintain a clear distinction between personal and business finances. Success as a limited company contractor often depends on staying organized, seeking expert advice when needed, and planning proactively for tax, pensions, and company closure if required.

If you are serious about contracting as a long-term career path and prepared to take ownership of your business operations, setting up a limited company could be the smartest decision you make.