IR35 Umbrella Company Pros & Cons

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ir35 umbrella company
ir35 umbrella company

Faced with being deemed an employee and not being able to work through their own personal service companies, many contractors will be prompted to work through different models, with umbrella being one option.

With the private sector off-payroll rules due to hit the contracting sector in April 2021, does the IR35 umbrella company model offer a more attractive solution to limited company status for contractors caught by the tax changes?

Large, multinational businesses have moved to impose blanket bans on working directly with limited companies post-IR35. Instead, by using contracts with umbrella companies, they will become instantly “IR35-compliant”. They also avoid additional admin work and insulate themselves against any potential financial liability to HMRC.

Limited companies versus umbrella companies

Today, the majority of contractors work through their own limited companies for a reason. The tax advantages of working this way outweigh any other compliant method and you remain in control of your own finances. Umbrella companies offer higher risk and lower tax efficiency than limited company operation.

With a limited company you are the director of your own private company. You have complete autonomy of how you work and who you work with. As a director you are fully in control of your own business and its financial affairs – this allows for greater opportunities for tax planning including drawing dividends, claiming expenses and making pension contributions. The downside? While you have the pros of being a director, you also have the additional responsibilities to HMRC and Companies House; which of course includes paperwork and financial management. This problem is easily solved however by appointing a specialised contractor accountant (like inniAccounts!).

PAYE umbrella companies for contractors: pros and cons

Umbrella employers provide contractors with full employment rights, all statutory benefits including holiday pay, maternity pay, paternity pay, sickness pay, pensions, redundancy pay and adoption pay.

A contractor is an employee of its chosen umbrella employer and with that comes a responsibility for the umbrella firm to provide all normal HR functions of any employment relationship – a compliant umbrella company cares for its employees, the contractors.

The contractor has the best of both worlds – the stability and benefits of being employed whilst also having the freedom and flexibility to undertake contract work for numerous end-clients.

There is continuity of employment even when undertaking placements for numerous different recruitment agencies. This continuity of employment history can be particularly important for anyone looking to access personal finance solutions such as mortgages and loans.

And, for anyone working on very short-term contracts (e.g. shifts changing daily) or working for multiple clients simultaneously, the umbrella consolidates earnings from the various assignments into one pay packet. This means that all tax and NICs are taken care of together for the contractor, rather than needing to consider earnings from each assignment separately.

A true umbrella will:

  • Employ you
  • Give you all statutory rights & benefits of employment (holiday pay, sick pay, pension etc)
  • Give you the flexibility for numerous different end-hirers
  • Consolidate your pay from numerous hirers into one pay packet
  • Process the full amount of your gross pay through PAYE

When you join an umbrella company, you effectively become an employee of that corporation. You’ll receive a salary that has been subject to PAYE tax and National Insurance. The fact your payments are being handled by a second party naturally introduces a level of risk; as you are reliant on the umbrella collecting money from your client or agent and using it to pay you.

Most reputable umbrella companies cost around £30 a week (£1,500 annually). However, there are usually additional costs associated. Services levied by umbrella companies can reach as much as 9% of the value of a contract, and many insist on contractors agreeing to a minimum level of charging or billable time; meaning the price can fluctuate (unlike accountancy fees which use set prices regardless of turnover). The benefits? Your financial affairs are handled by the umbrella; so there’s less paperwork and financial management. Most weeks you’ll merely be submitting a timesheet, and the company will manage the rest. However, this means you’re missing out on any tax planning opportunities.

Umbrella companies for contractors inside IR35

It’s important to remember that working in the public sector doesn’t necessarily mean your contract will be inside IR35 (several of our own clients have contracts with HMRC that are outside IR35). HMRC specifies that public authorities must assess their contracts on a case by case basis and not mandate IR35 across the organisation or insist that everyone uses an umbrella company. Unfortunately, this wasn’t necessarily the case following the introduction of the changes.

When the public sector changes came in the onus shifted from the contractor to the end client, many of whom were purchasing teams in public sector bodies with little understanding of IR35 and the extra processes involved. Many saw the new obligations and tax risks and resorted to short-sighted blanket bans. Such as the NHS deeming all contractors automatically inside IR35 and stipulations that all contractors have to be in an umbrella company.

These knee-jerk reactions were bad for everyone and unfortunately either saw contractors shifting to umbrella corporations as they were told or sticking with what was best for them and voting with their feet by leaving the public sector. Thankfully most of these decisions have now been repealed. Public authorities, like the NHS, will be examining contractors on a case by case basis as intended. But there remains plenty of misinformation both within the public sector and with contractors.

So why were public bodies and recruiters trying to push contractors towards umbrellas? In short, IR35 doesn’t impact umbrella companies. Contractors in umbrellas will already have PAYE tax and National Insurance deducted from their salaries; as if they were an employee. It’s clear why this would appeal to in-house purchasing teams and recruiters. Instead of having to assess IR35, make the necessary deductions if required and have a potential tax risk if mistakes are made, umbrella companies simply remove this additional requirement. It’s a simple and risk averse approach. The problem? It assumes a one-size-fits-all approach that leaves many contractors out of pocket.

Umbrella company risks

The vast majority of contractors and consultants remain outside IR35, and for work outside IR35 a brolly remains a tax inefficient means to operate.

For those independent professionals whose contracts are not permanently inside IR35, a limited company may outweigh the benefits of an umbrella. As well as remaining more tax-efficient, a limited company allows you to keep risk-free control over your business and to flexibly accept contracts both within the public and private sector; outside or inside IR35.

Converting to an umbrella company would mean that any future work you undertake outside IR35 would leave you significantly out of pocket. Plus, despite what agents may tell you, there’s nothing stopping you getting paid via a limited company if you’re inside IR35 – even in the public sector. The end client or agent can deduct your tax and NIC and pay the net amount to your limited company.

Contractors should choose their umbrella carefully as there are varying standards within the sector, with the worst players pretending to be umbrella whereas in reality they are actually tax avoidance schemes.

Confusion around the public sector changes and the following risk averse reactions have unfortunately seen a rise in non-compliant umbrella companies. Many umbrella schemes are promising unrealistic tax savings, plus the recent high-profile Loan Charge scandal has rocked the world of umbrellas – HMRC has broken all the rules in seeking back payment of taxes from Contractors duped into shady umbrellas.

On the other hand, some umbrellas are taking far larger cuts than contractors were originally expecting.

Staying limited?

As an independent professional, it’s important to continually assess the options that best suit you. The IR35 public sector application changes and the initial reaction from public sector bodies has seen wide spread discussion and growth of umbrella companies. Confusion and misinformation are still rife whenever talk of IR35 is raised. This has unfortunately seen a rise in bad practices from both the public sector and umbrella companies.

While umbrellas remove any question of the ‘dreaded’ IR35, for many contractors (especially those who only occasionally work inside IR35), they simply can’t compare to having your own limited company. Limited companies remain the most viable option for keeping control of your day to day business, managing your finances and returning home with more in your pocket; all while easily remaining compliant with HMRC with the help of your specialist accountant. The tax advantages of working this way continue to outweigh any other method.

Legal disclaimer

The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law and should not be treated as such.

Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.

Before acting on any of the information contained herein, expert legal or other advice should be sought.