All contractors need to consider the IR35 tax legislation issue which was introduced in 1999, and took hold in April, 2000. Below we have explained the ruling in more detail as well as listing its effects on contractors.
IR35 Explained
The legislation means that HM revenue can tax some contractors as if they are employees of their clients. Contractors caught by IR35 can pay considerably more tax which can see their pay being reduce by up to 25%
Contractors falling under IR35 will see the following apply to them:
- Employers N.I. of 12.% applied to all gross earnings*.
- Employees N.I. of 11% paid on all earnings within lower bracket.
- Employees N.I. of 1% paid on all earnings within upper bracket.
- PAYE of 40% paid on all earnings within higher rate tax bracket.
* Gross Earnings = (Revenue – Expenses) * (1/(1+employers NI rate))
Will legislation IR35 affect me?
We would say that most contractors will need to consider the effect of IR35 and if necessary be able to take action avoid it. However it must be stated that not every contractor will be affected by the legislation. If you are caught there are however steps you can take to negate its affect.
Using an umbrella company model against IR35
Contractors inside IR35 typically use an umbrella company as a way of outsourcing of their payroll, with the benefit being that the umbrella company benefactor would take care of all taxation and accountancy issues including any administration, this option is more cost effective than using a limited company structure, with would do little to shield against the effects of IR35.
Most schemes like this require contactors to already have an offer in place from an agent before they can join such a scheme. However the whole process is simple with most contractors being set up by their agent as a client within 24 hrs.
What to expect from an umbrella company:
- Firstly you will need to tell existing client the name of the umbrella company that you are dealing with. This helps to ensure that any contracts they prepare clearly state the umbrellas company name as the 'contractor'.
- The umbrella company will be the first to receive the contract by your agent. They will then arrange for it to be signed by their executive before they send it on to you for a counter signature and/or checking.
- The umbrella company will also need your name, address and bank details in dealing with any credit transfers to your account. They may therefore issue an application form requesting such information.
- You must send your P45 from your last employer to the umbrella company. If you do not have one then a P46 form will be issued from them so that they can obtain the necessary tax code.
- Most umbrella companies may ask you to sign their own legally binding document between yourself as a shareholder/ individual employee. Such a contract will outline the terms and conditions in which you agree to work under in regards to the service the umbrella company will provide as well as how you agree to be paid.
What are the advantages of using an umbrella company?
There are several advantages of using an umbrella company including:
- Such a model saves the time and effort of running a limited company. It is easy and simple to set up, with the contractor completing the timesheets and then forwarding it onto the umbrella company.
- The contractor can be free from VAT returns, payroll and taxation issues as well as worrying about the company accounts. This means they can concentrate on running their side of the business more effectively knowing any that any payments are being calculated properly.
- This model is very effective for short term contractors as they do not have to form a company which is expensive.