IR35 and Umbrella companies – how does contracting through an Umbrella company make a difference?

Understanding the directors loan account. Directors current account
Written by Phil Ainley
Last updated April 7, 2021
Main article image

When the off payroll working rules were introduced into the public sector in April 2017, it quickly became clear to contractors operating through their own limited company (Personal Service company or PSC) that if engagements were deemed “inside” IR35, they would be impacted as follows:

  • If they couldn’t negotiate a better day rate, it would be reduced by a deduction for employers’ NICs (and in some instances Apprenticeship levy as well);
  • The amount remaining would be taxed under PAYE as would any other employee, which means their take home would be significantly impacted;
  • An engagement which is inside IR35 means that you cannot claim your home to site travel; i.e. like an employee, they could not claim their commute – these costs would now come out of their take home pay.

However, the legislation also introduced one final piece of financial discomfort; the 5% notional allowance for expenses, which was previously allowed by the IR35 deemed calculation, would be removed for any engagement deemed inside where the fee payer was responsible for making the tax deductions.

What this meant was that once a PSC presented its invoice, very single penny would be accounted for as either deductions (tax, NICs. Apprenticeship Levy) or net pay. Go a whole tax year on this basis and you would have no profit, no loss; and certainly nothing to set your expenses off against.

If contractors were now having to pay their company’s running expenses from their take home pay; there would be little point in continuing to trade through their PSC.

As a consequence, many contractors joined umbrella companies. Many private sector contractors are already umbrella workers and it is likely that more will follow suit in April of this year.

Working for an umbrella company means that you are an employee of the umbrella and your day rate will be affected as above – you will be taxed as an employee – but with one further deduction: the umbrella’s margin for providing its services.

Many contractors find it easier because they don’t have the burden of PAYE and NIC to deal with and IR35 is not a concern for them.

There are also other benefits to working via an umbrella: holiday pay, sick pay, employee rights, pension contributions, insurance protection and other perks.

However, contractors must remain vigilant and ensure that the umbrella is compliant, a point we will address later in this article.

 

Calculating your take home pay

Day RatePSC (Outside IR35)PSC (Inside IR35)PAYE Umrella Employment
£200£3,337.43£2,822.83£2,903.00
£300£4,686.41£3,918.04£4,040.00
£400£5,871.03£4,967.10£5,137.00
£500£6,716.87£5,599.20£6,237.00
£600£7,901.50£6,648.26£7,334.00
£700£9,086.12£7,684.90£8,434.00

 

Results based on 40 hours per week, zero expenses, to illustrate the potential take home earnings using tax code 1250L.

PSC calculations taken from www.caunceohara.co.uk/ir35/resources/ir35-calculator/

PAYE Umbrella calculations taken from www.paystream.co.uk/umbrella/umbrella-take-home-calculator/

 

The potential effect on a contractor’s cash-flow

Another consideration for contractors working via a PSC inside IR35, is the potential effect on their cash-flow, based on the definition of the deemed salary calculation by the fee-payer.

The fee-payer (agency, end-client or third party), will be obliged to apply PAYE and employees NIC to the deemed salary calculation.

As it stands, the legislation tells fee payers to apply a BR tax code (a Basic Rate tax code taxes all income at the current basic rate of 20%, and ignores personal allowances). HMRC should contact you and your employer to make the necessary adjustments to ensure that you are taxed correctly, but this will take time

While claims for relief in relation to allowable expenses and pensions can be made via your self-assessment return, these typically take place after the financial year-end. This could leave contractors disadvantaged each month compared with working for an umbrella, where the correct tax code will be applied to each payment.

 

Ensure the umbrella you work for is ‘compliant’.

The most important word in all this is ‘compliant’. The moment you read a statement such as “Take home 85% of your pay”, or you are being offered a loan, or are told your funds will be diverted offshore to minimise tax, then you should seek an umbrella that will tax you under standard PAYE rules. As thousands of contractors have already found, these types of arrangements will come back to haunt you.

If you are asked to pay fees to enter a scheme, then you need to question this and whether the taxman will view it as compliant. The answer to that will be NO!

It is important to remember that HMRC do not approve arrangements that claim to avoid tax payments or boost take home pay. So, anything that says “HMRC Approved”, then it will be anything but.

The following figures are important to remember:

  • Everyone has a tax- free allowance of £12,570 per annum.
  • Income tax of 20% then due on earnings between £12,571 and £50,270.
  • 40% is then due on the next £50,271 to £125,140.
  • Earnings above £125,140 are taxed at 45%.

If your earnings are not being taxed at these rates then you are not working through an umbrella, you are likely to be working through a tax avoidance scheme.

 

Caunce O’Hara offer a range of business insurance solutions to help contractors stay protected including Tax Enquiry & Legal Expenses Insurance, which provides cover for costs incurred by a HMRC investigation. Tel 0333 321 1403.

Markel Tax offer specialist IR35 tax services to help end client decision-makers ensure they are compliant with the legislation. Agencies who may be concerned about their fee payer liability can also consider insurance. To find out more, please contact Markel Tax on 0345 223 2727.

 


Sources:


Related Articles:

How does an Umbrella company work?

 

 


Understanding the directors loan account. Directors current account
Written by Phil Ainley
Last updated April 7, 2021

Related IR35 content

Case law examples that have helped determine employment status and IR35

While IR35 as we know it has only been in existence since it was first announced in 1999, by the…

Read more

Managed Service Company (MSC) legislation: an expert’s overview for contractors

To understand the Managed Service Company (MSC) rules, given the limited case law on the subject, we must dive into…

Read more

Contracts with overseas fee-payers: pros and cons

A question that arose from a recent contractor survey is, ‘what are the pros and cons of working with overseas…

Read more

Contractors hit with huge tax bills for breaching Managed Service Company rules

It is 12 months since the changes to off-payroll legislation on 6 April 2021 went live. Navigating IR35 still remains…

Read more

What are the implications of being a UK resident, but running your company from overseas?

This subject is widely regarded as “complicated,” and if you find yourself in this position and require a detailed explanation…

Read more

What is the difference between project-based vs task-based engagements in relation to IR35?

Project-based vs task-based engagements The reason that we ask this question when reviewing an engagement is to understand the nature…

Read more

A brief explanation of the Key Information Document (KID)

Following on from our brief mention of the Key Information Document (KID) in our article “The Essential Guide to IR35…

Read more

Key stats about IR35 six months after the reform went live

Just over six months on from the April 2021 rollout of IR35 legislation to the private sector and the UK…

Read more

What do recruitment agencies need to do to protect themselves from IR35?

Recruitment agencies will be the parties viewed as being responsible for any unpaid tax as they’re considered the ‘fee-payer’ in…

Read more

IR35 and Umbrella companies – how does contracting through an Umbrella company make a difference?

When the off payroll working rules were introduced into the public sector in April 2017, it quickly became clear to…

Read more

What is my IR35 status?

As a private sector contractor operating through a Personal Service Company (PSC), you can’t afford to wait until April 2021…

Read more

Factors that determine IR35 status

IR35 v self-employment Just to clarify a key point before we begin, a contractor does not have to be engaged…

Read more

New IR35 Rules explained

After being delayed for a year due to the Coronavirus pandemic, the new private sector off-payroll working legislation (IR35) will…

Read more

How to protect against an IR35 tax investigation

If you receive a letter from HMRC regarding an IR35 tax enquiry it is important that you immediately seek advice…

Read more

What is IR35 and who does it apply to?

A useful starting point is to explore the background to the off-payroll working legislation (IR35), because the changes that came…

Read more

Can contractors working on contracts inside IR35 still work through a limited company?

The off payroll working rules, known as IR35, were rolled out into the private sector on April 6th, 2021. The…

Read more

Why end-client businesses should make their IR35 decisions now

IR35 decisions can be made now End-client businesses which engage contractors (whether directly or indirectly via agencies) must determine whether…

Read more

Fee payers: Your IR35 responsibilities and your liability

The fee payer is the party paying the contractor’s PSC; i.e. the entity directly above the contractor’s limited company in…

Read more

What to expect from a HMRC IR35 investigation

If you receive a letter from HMRC regarding an IR35 enquiry it is important that you seek advice from an…

Read more

Frequently asked questions about the IR35 in 2021

We have collated some of the most common questions asked about the IR35 changes, relevant to each area of the…

Read more

IR35 Where are we now and what does the future hold?

After the government’s postponement of the IR35 changes, the off-payroll legislation in the private sector reforms are now imminent. The…

Read more

Who pays the Piper? The Relevant Person and IR35 Debt Transfers

One of the most confusing issues with the new rules for IR35 which will come into force next April are…

Read more

6 Questions you need to ask yourself about IR35

The fundamentals of IR35 are NOT changing: understanding the key status indicators – personal service, control, and mutuality of obligations – is…

Read more

The impact on contractors of the deferral of private sector IR35 reform until April 2021

Since Steve Barclay, the Chief Secretary to the Treasury announced a 12-month delay to the IR35 private sector reform in…

Read more

Why do I need an IR35 contract review?

Get a clear explanation of your IR35 status If you are a contractor with any doubts as to the compliance…

Read more

What is a Personal Service Company?

Found across all industries, a Personal Service Company (PSC) is a company which provides personal services of a single contractor…

Read more

What is IR35 and how does it work?

IR35 – or the Intermediaries Legislation – was introduced by HMRC in 2000, and was aimed at individuals who were…

Read more

What is a contract review and do I need one?

A Contact Review is a report that independent tax specialists such as Markel Tax provide to contractors giving an opinion…

Read more

IR35 changes 2021: What you need to know

IR35 effective from April 2021 The Government has reaffirmed plans to make changes to off-payroll working (IR35) rules effective from…

Read more

What is inside and outside IR35

No statutory definition of a contract of service There is no statutory definition of a contract of service (employment contract)…

Read more

Will contractors still need insurance for IR35 after April 6th?

Amendment: On March the 18th 2020, the Government announced that the roll-out of private sector IR35 reform would be postponed…

Read more

What is IR35 and how will it affect you as a freelance contractor?

For many freelancers, IR35 sounds like another jargon term that has no relevance to them and there is a concerning…

Read more

The Right of Substitution

The right of substitution is one of the key tests of your IR35 employment status as set out by the…

Read more

Mutuality of Obligation (MOO)

Mutuality of Obligation refers to the obligation of the employer to provide work and pay for it. This is combined…

Read more

Retain your control as a contractor to keep IR35 at bay

Control is one of the three key points that is used to determine whether a contractor is working inside IR35…

Read more

The importance of an IR35 Contract Review for private sector contractors

If you are a private sector contractor, you should be fully aware of the private sector IR35 changes that are…

Read more

What is IR35 and how does it affect you?

Whether you’re new to contracting or an old-hand, the issue of IR35 is never far away.  IR35 status affects your…

Read more

PSCs inside IR35 – Keep Calm and carry out some research

A week on since the Finance Bill 2017 became law public sector contractors who operate through PSCs are facing a…

Read more

IR35 Products & services

Caunce O’Hara’s partnership with Markel enables us to offer a broad range of IR35-based products to protect contractors, fee-payers and end clients across the UK.

IR35 Hub Related IR35 content