Why brollies aren't a must for IR35-caught PSCs

Given that the contractor industry could do with clarity as April 6th approaches, the idea being pushed by umbrellas that every PSC has to choose between being employed or being a PAYE brolly contractor needs calling out, writes Carolyn Walsh of CWC Accounting Solutions.

Meet Mark. Based in Surrey, Marks works as a project manager supplying his professional services through ‘M.Ark’s Random Tech Name Limited’ (MARTN Ltd) to an engineering corporation. So MARTN Ltd is a personal service company and it invoiced the engineering corporation £75,000 plus VAT for Mark’s services last year.

Are you like Mark?

Mark generally works from a home office, using his own equipment, apart from a laptop supplied by the engineering client so that he can access data stored on the corporation’s intranet. He is asked to complete various projects lasting from a few days, to some that are expected to last two or three years. He receives a project specification, which he organises to his own satisfaction using the skills that he has built up from years of experience and from paying for various accreditation courses. He also draws on the IT and physical resources that he has available. He attends meetings and site visits on an ad-hoc basis and occasionally represents the engineering corporation when speaking to clients, although he does not hide the fact that he is the director of MARTN Ltd. He even directs people he meets to adverts and pages MARTN Ltd has on social media and networking platforms like LinkedIn.

Mark’s working practices (continued)

Mark doesn’t expect any obligation on the part of the engineering company to provide him with contracts permanently and he has built up a network of over 600 contacts within his industry.

If Mark was to describe himself at work it would be as a 'lone wolf.' He answers to no-one, although if he is found to have been negligent he understands that it is for him to put things right, or to suffer the consequences financially. For this reason he holds both public liability and professional indemnity insurance policies.

Mark engages a high street accountant to manage the filing of his company accounts and to run the payroll for his director’s salary of £20,000 per year. He was also registered under the VAT Flat Rate Scheme as a consultant at the (currently) 14.5% rate, which more or less equalled the VAT paid on his company’s purchase invoices.

The following is a reflection of MARTN Ltd’s tax and NI position:

Figure 1

MARTN Ltd (outside IR35, paying VAT FRS @14.5%, and with expenses)

Balance Sheet year ending March 2018

Company Income £75,000.00
Output VAT £15,000.00
Salary £20,000.00
Employer NIC £1,633.37
Business Expenses £17,000.00
Work Expenses inc mileage £10,000.00
VAT FRS payment £12,600.00
Corporation Tax £4,794.44
Dividend Tax £1,797.91
HMRC Liability £23,946.04

 

When IR35 applies

In May 2017, Mark is offered work with another engineering outfit, but this time the outfit is in the public sector. This public sector body insists that Mark’s company operates IR35. He predicts his business expenses will reduce and so he falls within the definition from April 2017 of a ‘Limited Cost’ trader, which means the percentage rate payable on the Flat Rate VAT Scheme to HMRC rises to 16.5%.

So MARTN Ltd’s position -- by the end of the year -- that Mark works via, for the public sector engineering body would look something like this: he would be roughly £9,500 a year worse off working under IR35 in conjunction with the new, higher rate under the VAT FRS. And if he deregistered for VAT, he would be around £11,000 a year worse off!

Figure 2

MARTN Ltd (inside IR35, paying VAT FRS @16.5%, with expenses)

IR35 Calculation year ending March 2018

Company Income £75,000.00
Output VAT £15,000.00
Salary £50,000.00
Employer NIC £5,773.37
Business Expenses £1,800.00
Work Expenses inc mileage £15,000.00
VAT FRS payment £14,850.00
Corporation Tax £0.00
Dividend Tax £0.00
Deemed Income £2,576.63
Total Receipts £90,000.00
   
VAT FRS payment £14,850.00
Employer NIC £5,773.37
PAYE £9,800.00
Corporation Tax £0.00
Dividend Tax £0.00
HMRC Liability £34,889.89

Under Chapter 10 Income Tax (Earnings and Pensions) Act 2003 (amended April 2017), known as the Off-Payroll rules, the public sector body is required to make the deduction under IR35 before paying the contractor’s company. Often that responsibility would fall to the agency or a service provider. So to be on the safe side, Mark keeps track of his company’s IR35 position using an independent service provider which costs around £500 per year. But this cost ensures that overpaid tax and NI deductions are able to be recovered, and he is satisfied as the cost is met by the savings made on not needing an accountant to manage his company accounts.

When PAYE umbrella applies

After a few weeks the public sector body decides that all contractors must be paid via a PAYE umbrella company. An annual payroll summary outlines that Mark’s payment via ‘MARB,’ a PAYE umbrella company, will be treated for tax and NI in the way depicted in Figure 3, below.

As umbrella companies can no longer offset work expenses, Mark will have to wait until the end of the tax year to make a claim for tax relief on his business and work expenses. He doesn’t receive the rebate under the FRS, so has lost the ability to recover the VAT paid on his company’s purchase invoices. Also, because the PAYE and NI deductions are much higher following the move to MARB, Mark now finds himself a total of nearly £20,000 a year worse off.

Figure 3

Income paid by M.Ark’s Random Brolly (MARB), a PAYE umbrella company

  Pay Elements HMRC Liabilities
Payment to Umbrella Company £75,000.00  
Fees £1,820.00  
Holiday Pay £7,881.53  
Income £57,413.92  
Employer NIC £7,884.56 £7,884.56
PAYE   £13,965.57
Employee NIC   £4,671.80
  £75,000.00 £26,521.92

To summarise, here is a list of ways to manage the new off-payroll working in the public sector legislation, albeit from a different angle to that being promoted by PAYE umbrella companies.

Final considerations

  1. Contractors should ask for a review of their contract with the public sector body as these bodies may wrongly deem them inside the IR35 legislation, whereas an IR35 review could prove that the IR35 reforms do not apply.
  2. Where contractors are caught by the new legislation, they should consider refusing to accept the PAYE umbrella option, if they are interested in optimum take-home pay. There are service providers which will instead manage deductions under IR35 on behalf of agencies working in public sector body supply chains, which most agencies believe to be compliant. Even without this new, anticipated batch of service providers, where IR35 applies, the most tax-efficient route for a PSC is likely to NOT become a PAYE umbrella worker -- it is to operate IR35, as the figures in this article show.
  3. Contractors will be subject to income tax deductions of 20% to potentially up to 45%, where PAYE is operated on the income of a personal service company in order to comply with the off-payroll working rules in the public sector (Chapter 10 ITEPA 2003). But just as in parts of the construction industry, where deductions are made at 20% to 30% by hirers, sub-contractors file a self-assessment return each year, offsetting deductions against their true tax and NI liabilities. This ensures that construction industry sub-contractors receive a rebate and contractors working in the public sector can receive the same.
  4. While a contractor’s company income is subject to deduction under IR35 by a public sector body or a service provider working in the supply chain, contractors should be mindful of monitoring their company’s true IR35 position, either using an independent service provider or by using a free-to-use IR35 calculator.

Editor’s Note: The author, Carolyn Walsh, is the director of CWC Accounting Solutions Ltd and Andraste Accounting Ltd. Formerly of the Inland Revenue (now HMRC), she is also a stakeholder in HMRC consultations involving employment status.

Mar 06, 2017