How does IR35 work for umbrella companies?

Last month, it was reported that more than 40,000 people from the Philippines had been recruited to front British companies as part of mini Umbrella companies. With it being reported that the UK is losing millions from schemes like this, there have been calls for HMRC to act.

While it is not been reported that the schemes are illegal, contractors should err on the side of caution to ensure they have not signed up for a tax avoidance scheme. HMRC’s guidance on umbrella companies states “if you are asked to sign an annuity, loan or other agreement involving a non-taxable element of pay, especially if this involves someone other than your employer, it may be a tax avoidance scheme”.

The spike in umbrella companies could be due to the IR35 reforms, which came into play a few months ago. But what is an umbrella company? And why are some contractors signing up for them?

What is an umbrella company?

An umbrella company is a company that self-employed contractors can register to work through, as opposed to having to work under a limited company. By joining an umbrella company, a contractor becomes an employee of that company.

The umbrella company would get paid for the work a contractor has completed, and then pay the contractor – deducting tax and national insurance payments, and any administration charges applied by the Umbrella company.

Umbrella companies do not normally find work for a contractor; their main purpose is to deal with the administration of payments for contractors. As stated on the Gov.uk website, the umbrella company should provide you with a payslip, which should include the following information:

• Your pay, before and after any deductions.
• A breakdown of how much has been deducted, for example how much National Insurance Contributions (NICs) and Income Tax you have paid.
• The hours you worked, if the payment terms mean you get paid an hourly wage.

An umbrella company is only allowed to deduct payments that are required by law (i.e. taxes), deductions that you have agreed to, and deductions your contractors say they can take.

Why would contractors use an umbrella company?

When working through a UK-based umbrella company, contractors wouldn’t get the same tax benefits as a contractor working through a limited company. New contractors may choose to work this way if they don’t want the hassle of setting up a limited company.

Contractors often get access to benefits usually only offered to full-time employees, such as a workplace pension, sick pay, holiday pay, and parental leave. As a contractor, you would have to weigh up if you would rather have these benefits and pay the same tax and National Insurance payments as a full-time employee.

Umbrella companies and IR35

More contractors may be shifting to working through an umbrella company due to the IR35 reforms. On the 6th April this year, the tax liability changed from contractors to their fee-payer, which saw some clients decide to no longer engage with outside IR35 contractors.

Kingsbridge completed a survey before the IR35 reforms, where 10% of contractors said they had already been subject to a blanket inside determination. While some contractors said they would not accept this, for those contractors that have been blanket banned or placed inside IR35, closing their company and working through an umbrella may be their chosen next step.

Contractors should proceed with caution

Using an umbrella company may be the solution for some contractors, especially in the wake of the IR35 reforms. HMRC acknowledge that most umbrella companies are compliant with tax rules. However, it’s worth doing your research and making sure that the company is legitimate if you decide to make the change.

As the age-old saying goes, if it sounds too good to be true, it probably is. You should always consult with your accountant before making the change or making the decision to close your limited company.

If you are concerned about your IR35 status or getting an inside determination, one option you could look at is Kingsbridge’s award-winning status tool. Our hybrid tool combines the best of both; a fully automated tool with a series of questions developed by our Head of Tax, Andy Vessey, paired with manual intervention by our expert IR35 team for any indeterminate results.

Buy a review here for just £50 plus VAT.