Contractors' Questions: Umbrella or Ltd Co, which is best for expenses?

Contractor’s Question: Which will be more lenient or liberal as a regime for claimable expenses, an umbrella company or a limited company? I was thinking of using an umbrella company and becoming one of its employees but this ContractorUK article says (in the last paragraph) that the taxman’s expenses test for employees is stricter than it is for a company. But I’m confused about which test would apply if I don’t opt for an umbrella, because if I set up my own limited company as its director wouldn’t I also be an employee of the company?

Expert’s Answer: With many queries about contractor expenses, including this question, it is difficult to generalise, partly owing to the complexity of HM Revenue & Customs’ associated rules.

With a limited company there are two legal entities. The limited company test for expenses is whether the expenditure is for the “purpose of the trade” but, as you say, the director is the employee, who could benefit from that expenditure so there could be a tax liability on the employee. 

For expenses other than travel, the expenses test for an employee is “wholly, exclusively and necessarily in the performance of the duties of the employment.” The test for employee travel is more lenient than this, but there is still the requirement that, for the travel to be claimable, it must be "in the performance of the duties”. I think it is fair to say that if the expense passes the latter tests it will also pass the former test.  

Let’s remind ourselves of what I said in the article you refer to: The test for allowable expenditure is less strict for the company than for the employee. For an employee, it is “wholly exclusively and necessarily in the performance of the duties of the employment”, whereas for the company it is “wholly and exclusively for the purpose of the trade”, which is an easier test to pass.

With this in mind, consider the following scenario.

An employee is out of work and incurs expenditure in writing letters/applying for jobs, telephoning, and attending interviews. This is NOT expenditure incurred in the performance of the duties of the employment because there is no employment. Even if the employee was coming to the end of an employment, any expenditure on seeking a new employment would not be in the performance of the duties of the old employment. However a limited company, as part of its trade, will seek new contracts and expenditure incurred in that respect WILL qualify.

The guidance I tried to give in the original article still stands and is worth reiterating: that there are some circumstances where expenses would be allowable under the limited company route which would not be allowable if you were simply an employee and claimed a tax repayment from HMRC.

Bear in mind though, in the article you refer to I purposefully used the term “employee” and not “employee of an umbrella company” as different umbrellas operate in different ways and make different claims as to what is and isn’t allowable.  

The Expert was Bob, the retired tax inspector.