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 Rate | PSC (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:
- markeltax.co.uk
- caunceohara.co.uk/ir35/resources/ir35-calculator/
- paystream.co.uk/umbrella/umbrella-take-home-calculator/
- gov.uk
- contractoruk.com
- wttconsulting.co.uk
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