Why the consultations on umbrella companies and IR35 offset may be a boon for limited companies

Since the off-payroll working rules came into force in 2017 and 2021, hirers have become responsible for the employment status compliance of the contractors they engage.

Many hirers have been playing it safe, forcing independent contractors to work under umbrella companies, rather than risking working with Personal Service Companies (PSCs).

But two government consultations – the recently-closed one on an IR35 offset and the other still live one on umbrella regulation -- appear poised to shift the equilibrium of risk back towards limited companies as a safer option, writes Matt Fryer, managing director of Brookson Group.

Why is PSC contracting not what it once was?

Under today’s IR35 rules, except where the end-hirer is a small company, the responsibility for determining contractor employment status (and ensuring the correct employment tax payments are made), rests with the end-hirer.

Enforced by HMRC in both the public and private sectors, the rules state that should the hirer misclassify the tax status of contractors as falling outside IR35, or if any entity within the contracting supply chain neglects their tax obligations, the hirer could be held accountable for additional tax and NIC. This latter provision explains their caution -- the ‘play it safe’ approach I mentioned at the outset – and it’s resulted in the heavy blanket banning of PSCs.

The caution has led to a proportional increase in the use of umbrella companies. Given the narrow margins for role fulfilment and a lack of understanding by some on how umbrellas should be properly run, this has ignited competition within the market -- and commercial pressures have resulted in instances of reduced quality standards and non-compliance.

Open until Aug 29, the government umbrella consultation might make a mess messier

Many in the contractor industry have long-called for a cleaning up of the messy contractor tax landscape. But unfortunately the proposed umbrella consultation could make it messier!

To recoup taxes evaded by non-compliant umbrella companies, the consultation’s proposals introduce a mechanism for transferring debts up through supply chains. This debt would ultimately fall upon either the agency or the end-hirer.

Additionally, knowing they would be let off scot-free, this could incentivise some umbrella companies to act non-compliantly.

Now awaiting the government’s response, the IR35 consultation will improve IR35

A second government consultation with big implications for the contractor sector is concerned with offsetting double taxation for incorrect outside IR35 determinations. With a potential commencement date of April 6th 2024, this proposal could make working with PSCs seem more favourable compared to umbrellas.

Currently, HMRC does not have a provision to offset taxes that have been paid by both the end-hirer and the contractor.

The proposed offset mechanism aims to allocate the tax obligation in a more just manner between the deemed employer and the contractor, which will result in a potential halving of the perceived tax risk associated with hirers engaging with outside IR35 contracts.

Contractor case study: an example of set-off and debt transfer based on a £400 day rate

Should both of these proposals be enacted by the commencement of the upcoming tax year, the confluence of the IR35 offset mechanism and the umbrella ‘debt transfer’ risk will substantially reduce the level of risk (and deterrent) linked with limited companies.

And the numbers make the case. For example, consider the scenario of a contractor with a daily assignment rate of £400 (£2,000 a week):

  • If the contractor were to operate through a non-compliant umbrella company employing a common tax avoidance scheme, and assuming the proposed debt transfer regulations are implemented, the potential tax and NIC liability for the agency/hirer could reach £695 a week (equivalent to 35% of the assignment rate).
  • If the contractor engaged through a PSC in a role initially deemed outside IR35 but subsequently argued by HMRC to be within IR35, the potential tax and NIC liability for the deemed employer, with the proposed set-off mechanism in play, would amount to £275 per week (equivalent to 14% of the assignment rate).

Ouch, that’s a disincentive of more than £20k

In this specific instance, the escalated risk associated with dealing with a non-compliant umbrella company, compared to a PSC mistakenly classified under IR35, would translate to £22,000 annually.

Such a scenario has the potential to be transformative for hirers across various sectors, very possibly prompting a renewed inclination to properly comply with the off-payroll rules and work with authentic independent contractors on outside IR35 contracts via PSCs.

The resurgence of PSCs

Anticipating more stringent regulations from HMRC targeting non-compliance, the potential hazards linked to umbrella companies might soon surpass those linked to PSCs.

By early-mid April 2024, there could be a resurgence in the preference for PSCs among end hirers, so they can access specialised expertise while bearing reduced tax risk.

This shift might even start to unblock the blanket barriers put on PSCs, which would open the way for highly skilled contractors to work with organisations that may have initially erred on the side of caution.

What’s next for contractors?

If these proposals are enacted as anticipated, it could be time, at last, for veteran contractors to dust off their dormant limited companies and enjoy greater access to outside IR35 contracts. Whether you’re a contractor with a dormant PSC or if you’re new to navigating the compliance areas and changes tied to these two significant consultations, consider speaking to specialist contractor accountant to gauge whether working through a limited company is the best future route for you.

Profile picture for user Matt Fryer

Written by Matt Fryer

Matt is a Chartered Tax Advisor with 18 years' experience of advising on tax planning and compliance. Matt has been with Brookson since 2009, having previously worked for Big 4 accountants, KPMG and PwC. Matt’s primary role is to ensure that the services provided by the Brookson Group comply with relevant legislation and regulatory requirements. Matt is also a Board member of the FCSA, the UK's leading membership body dedicated to promoting supply chain compliance for the temporary labour market.

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