Following the introduction of IR35 changes in the public sector, forcing contractors and freelancers onto payroll, roll out of the same within the private sector is imminent. As a result, many contractors and freelancers will have to work for umbrella companies. These employ contractors on temporary contracts, usually through a recruitment agency.
The umbrella company bills the agency that recruited the contractor or freelancer. The agency then bills the end client for whom the contractor or freelancer works.
The contractor or freelancer receives a payslip from the umbrella company, showing how much they’ve been paid, together with deductions taken, including income tax, National Insurance contributions, pension contributions, holiday pay and any work-related expenses, etc.
Along with the agency, the umbrella company charges a fee for processing the payroll on behalf of the contractor or freelancer.
That all sounds straightforward enough. Except a small number of dodgy umbrella companies out there are promising high rates of take-home pay to contractors and freelancers. And these – especially those claiming to offer more than 90% take-home pay – can only be achieved by operating a scheme.
A scheme is an artificial transaction, usually entered into to arrange your tax affairs to reduce your overall tax liability. Often the scheme promoter will claim that it’s HMRC-approved or they have legal opinion supporting that the artificial arrangement is “all above board”.
However, HMRC may, at any point in the future, challenge this arrangement and put it outside of the law. By this point, the scheme promoter may well have scarpered, leaving you, the contractor or freelancer, in dispute with HMRC over unpaid tax, fines and penalties.
The best advice is to avoid such schemes or anything that remotely looks like one, no matter how much the scheme promoter protests or tells you otherwise.
If it looks too good to be true – it will be. And you’ll only land yourself in a stressful position of having to take on HMRC, while possibly having to cough up much more than if everything had been above board. Moreover, in future, HMRC will closely inspect the tax affairs of scheme users – which isn’t a good position to find yourself in.
Unfortunately, some contractors and freelancers are unwittingly finding themselves in such schemes, with some even finding unexplained expenses on their payslip. A contractor or freelancer can claim for allowable work-related expenses, of course, but the expenses must be legitimate and actually incurred. Round-sum amounts or allowances are not generally permitted.
In one recent example brought to our attention, a nurse received a payslip with very large and unusual expenses recorded. She didn’t recognise the amount as anything that she would have claimed. In this case, the expenses had reduced the amount of taxable pay.
However, the expenses were not legitimate; they were merely used to reduce the overall tax liability. Although it was done without the nurse’s knowledge and consent, when HMRC come knocking, they’ll pursue her for the additional tax due.
We advised her to query the pre-tax deductions with the umbrella company and, if they cannot provide a suitable explanation, ask them to remove the deductions, pay the right amount of tax and then move to a reputable umbrella company.
The objection that we commonly hear from contractors and freelancers is they can’t move, because their agency tells them they must use their preferred umbrella company. Often, this is because the agency receives an incentive from the umbrella company. The incentive isn’t declared and the preferential relationship is hidden from the contractor or freelancer.
However, you can choose your umbrella company. Your agency may apply pressure, given their vested interest, but – they cannot force you into using a particular umbrella company. And, furthermore, they cannot threaten to withdraw the work or your contract. The agency must accommodate your choice of umbrella company.
Make sure that you’re happy with your choice of umbrella company, because you’ll be the one that could one day have to face the consequences of this key decision.