When the off-payroll working rules, commonly referred to as IR35, were introduced into the public sector in April 2017, it sent ripples through the contractor landscape. For those accustomed to operating through their own limited company (Personal Service company or PSC), the implications were profound:

1. Reduced Earnings: Contractors falling under IR35 had to contend with the possibility of reduced day rates, with employers’ National Insurance Contributions (NICs) and, in some cases, Apprenticeship Levy deducted from their earnings.
2. Shift to PAYE: Payments for engagements deemed “inside” IR35 would be subject to PAYE taxation, mirroring the tax structure of regular employees. This shift significantly impacted take-home pay.
3. Loss of Travel Expenses: Contractors could no longer claim home-to-site travel expenses, effectively treating their commutes as non-reimbursable costs.

To make matters more challenging, the 5% notional allowance for expenses, previously permitted by the IR35 deemed calculation, was eliminated for engagements deemed inside IR35 where the fee payer assumed responsibility for tax deductions.

This meant that every penny invoiced would either go towards deductions (tax, NICs, Apprenticeship Levy) or net pay. Over a tax year, this approach left contractors with neither profit nor loss, rendering trading through a PSC less appealing.

In response, many contractors turned to umbrella companies. Today, an increasing number of private sector contractors are choosing the umbrella route, with more expected to follow suit.

Working under an umbrella company entails a transition to employee status. While this entails being taxed as an employee, there is one additional deduction: the umbrella company’s service margin.

Many contractors find this transition appealing because it relieves them of the administrative burdens of PAYE and NIC, as well as concerns related to IR35.

Moreover, working through an umbrella company comes with additional benefits such as holiday pay, sick pay, employee rights, pension contributions, insurance protection, and more.

Nonetheless, it’s crucial for contractors to exercise due diligence and ensure the chosen umbrella company operates in compliance with the law—a point we’ll delve into shortly.

Cash Flow Considerations for PSC Contractors Inside IR35

For contractors operating within a PSC and falling under IR35, there’s another factor to consider: the potential impact on cash flow. This hinges on the deemed salary calculation determined by the fee payer (agency, end-client, or third party).

Fee payers are required to apply PAYE and employees’ NICs to the deemed salary calculation. Presently, the legislation mandates the use of a BR tax code (Basic Rate tax code), taxing all income at the basic rate of 20%, bypassing personal allowances. HMRC will eventually reach out to adjust your tax correctly, but this process takes time.

While relief claims related to allowable expenses and pensions can be made during self-assessment returns, these typically occur after the financial year-end. Consequently, contractors may find themselves at a monthly disadvantage compared to umbrella workers, who receive payments under the correct tax code for each transaction.

Ensuring Compliance: The Key to a Smooth Transition

In this context, the most pivotal word is ‘compliant.’ Any statement suggesting you can “take home 85% of your pay,” offers of loans, or promises to divert funds offshore for tax minimization should raise red flags. It’s essential to seek an umbrella company that adheres to standard PAYE rules, as arrangements claiming to avoid tax or inflate take-home pay often lead to consequences.

Be cautious of schemes requesting fees for entry, as these are likely to be viewed unfavorably by tax authorities. HMRC does not endorse arrangements that seek to evade tax payments or artificially boost take-home pay. So, claims of “HMRC Approved” should be approached skeptically.

Here are some key figures to keep in mind:

• Everyone enjoys a tax-free allowance of £12,570 per annum.
• Income tax of 20% applies to earnings between £12,571 and £50,270.
• Earnings from £50,271 to £125,140 are taxed at 40%.
• Earnings exceeding £125,140 face a 45% tax rate.

If your earnings are not being taxed at these rates, it’s an indication that you’re not working through a compliant umbrella company and might be operating within a tax avoidance scheme.

Choosing the right Umbrella Company can be daunting with numerous options available. While the calculations should align across companies, it’s essential to select one that offers additional advantages and operates transparently and ethically. Contact Agency Payroll today to explore how our services distinguish us from the competition and provide peace of mind for your tax and payment needs.