Contractor trading structures

As a contractor starting out or reviewing the way you operate, the prospect of cutting through legislative double-speak, service provider PR and the individual preferences of seasoned contractors, can seem a daunting task.

In this section we give you a potted history of trading structures to date and offer a simple guide on your options for 2007.

The "big story" for early 2007 is the government's MSC (Managed Service Companies) legislation removing the tax advantage that composite and managed service companies offered their clients. Working through an MSC would now subject you to employed levels of tax and NICs, therefore these structures are no longer viable or available. Information and news relating to the MSC legislation is at the bottom of this section.

What are my options?

These recent developments have simplified the choice for contractors and freelancers: form your own limited company or use an umbrella company.

Your own circumstances and preference will dictate which way of operating suits you. Generally contractors who are only contracting for short periods or simply do not want the hassle of paperwork and the responsibility that comes with running their own limited company will choose an umbrella. The financial returns by trading through an umbrella will be much less, particularly if you are outside IR35. It is best to speak to a good accountant and ask them what levels of income you could expect using either option. As a rough guide you could also use the income calculators.

Setting up a limited company means that you are running your own business. You will be the Company Director, operate the Company bank account, and be responsible for the affairs of the Company.

You will have complete control of the running of your company and the company bank account. You may draw dividends from that company provided that your contract falls outside of IR35.

Running your own limited company is the most tax efficient way of working as you keep more of your income. Keeping complete financial and administrative control ensures your money is not risked with any third party administrator. You are also free to undertake other work outside your normal contract role and legitimately claim a wider range of expenses (training, equipment, software, etc).

There are of course more responsibilities in terms of paperwork and deadlines, but a good accountant will be able to minimise this burden.

More information on running your company here.

Umbrella Company

Joining an umbrella means you become a PAYE (Pay As You Earn) employee of the Umbrella. Your client or agent enters a contract with the Umbrella for your services and you enter into a contract with the umbrella.

An umbrella company will raise invoices on your behalf and will be responsible for your tax and national insurance payments. The umbrella will always pay you through PAYE regardless of your IR35 status.

The benefits are that it is very easy to use, all your tax and NI are deducted before you get paid. You simply send in your timesheet and expense details.

You won't keep as much of your money with an umbrella and you are reliant on that company collecting your money from the client or agent and then paying you.

More information on using an Umbrella company here.

Managed Service and Composite Companies

In the chancellor's pre-Budget announcement on the 6th December 2006 he unveiled new proposals to remove the tax advantage that composite and managed service companies can offer their clients.

In the Treasury's document Tackling Managed Service Companies(PDF), the following excerpt lays down the intentions of the legislation:

"The Government is taking action to tackle Managed Service Company (MSC) schemes which are used to avoid paying employed levels of tax and NICs. Income received by workers in MSCs in relation to services provided through the MSC will be subject to employed levels of tax and NICs, with the MSC obliged to operate Pay As You Earn (PAYE) and deduct tax and Class 1 NICs on that income - and the rules for tax relief for travel expenses will be the same as for other employed workers. The Government will also address the problem of MSCs escaping payment of tax and NICs due by allowing the recovery of these debts from appropriate third parties.

"This will protect the Exchequer and ensure a level playing field for compliant businesses and workers. The Intermediaries legislation will remain in place for Personal Service Companies."

Appropriate third parties are deemed to be those which have "encouraged, facilitated or otherwise actively been involved in the provision by the MSC of the worker". MSC scheme providers, and directors, office holders or associates of the MSC, will therefore be pursued by the taxman for the recovery of employment taxes. Workers in the MSC remain within the scope of the debt transfer provisions, and seem likely to be liable for debts when they can be shown to have known that they were operating for a MSC.

The government has said it will defer the 'third party' debt transfer rules. Key facts below:

• From 6 April 2007 all payments received by individuals providing their services through Managed Service Companies (MSCs) will be subject to PAYE;
• From the same date the cost of travel from the individual's home to the individual's place of work is not an allowable tax-free expense for workers within MSCs;
• It is planned that from 6 August 2007 National Insurance Contributions will also be due on all payments received by individuals working through MSCs;
• Also from August, where the PAYE and NICs debts of an MSC cannot be recovered from the company, HMRC may transfer the debt personally to:

HM Treasury Transfer of PAYE debts (pdf)

Further Reading on Managed Service Companies:

Industry-led MSC schemes 'are no surprise'
Fear and loathing of debt transfer has compelled industry to act.
Jan 30, 2008

Taxman axes MSC audit scheme
Experts are no longer alone in thinking a plan to accredit MSCs is flawed.
Dec 18, 2007

Revenue clarifies MSC legislation
Contractors can prevent agencies from being liable for MSC debts.
Oct 16, 2007

MSC audit scheme 'would be useless'
A call to accredit service providers is being considered by HMRC.
Sep 19, 2007