When IR35 reform leads limited company contractors to use an umbrella company

Private sector IR35 reform is imminent and for some limited company contractors, this will mean being asked to work through an umbrella company, perhaps for the first time.

This could be an uncomfortable position for seasoned contractors that have not previously needed to use an umbrella company to be in, and not just financially, writes Joanne Harris, technical commercial manager at SJD Accountancy. So, what do you need to know?

What is a compliant umbrella? Explainer if you’re a first-time user

An umbrella company will become your employer both for legal and tax purposes. This means that as one of your umbrella company’s employees, you will receive the same rights and protections in law as any other employee.

Your umbrella employer will invoice the recruitment agency or end-hirer for the work you complete, and will pay the required Employer National Insurance, Apprentice Levy, Employer Pension Contributions and Holiday Pay from this income, after retaining their margin. The remainder forms your ‘gross pay’ and PAYE tax and NI deductions are made to this before you are paid your ‘net pay.’

What ‘umbrellas’ should ex-limited company workers stay away from?

If you have come across an ‘umbrella company’ that is offering you anything other than employment with PAYE tax and NI deductions, and potentially some tax relief on restricted expenses, be sceptical.

Unfortunately, there are still tax avoidance schemes out there that actively target contractors with promises of take-home pay that cannot be achieved by legitimate means. Stay away -- you could end up paying a hefty price further down the line.

You now know about gross pay and net pay. But what is your ‘assignment rate?’

This is an important point. It is essential that you understand what is included within the ‘assignment rate.’ It will be quoted to you.

Since April 2020, it has been a legal requirement for ‘employment businesses’ (recruitment agencies) to provide work-seekers with a Key Information Document. This KIDS should clearly state all deductions that will be made from the rate for a particular pay method (whether that be umbrella, PAYE or PSC working). This is your assignment rate.

You should receive one for each of the pay methods available to you. If you have not seen one, request it. A good umbrella company will work with your agency to ensure this is representative and will also offer you a pay illustration on request.

Fine. But what about expenses I previously got as a PSC, now I’m using a brolly?

When working through your own limited company you can claim tax relief on legitimate business expenses incurred ‘wholly and exclusively for the purposes of trade’. But as an employee of an umbrella company, the expenses that you can claim tax relief on are limited -- think ‘employee,’ not ‘business owner’ and you’ll soon get the hang of what’s allowable.

There are many pieces of legislation that impact the ability of umbrella employees to claim expenses. The most recent being the introduction of the Travel and Subsistence legislation in 2016. In short, if you are subject to, or anyone has the right over you of Supervision, Direction or Control (‘SDC’), you are unable to benefit from tax relief on travel expenses to your main place of work. And given that ‘Control’ is a key factor in determining IR35 status, if you have received an inside IR35 determination that has been fairly assessed, it is likely you will also be found subject to SDC.

Of course, you can still benefit from the usual tax reliefs available to all employees. All umbrella employers are legally required to opt you into a workplace pension scheme at 12 weeks. However most umbrella employers will go further than this and can make employer’s contributions into a pension scheme on your behalf, which, in addition to being a great way to save for your retirement, will mean you benefit from both tax and NI savings.

Right. But in practice, how to choose an umbrella company?

The umbrella company you do settle on will become your employer and be responsible for paying you, so it is important you are comfortable with them.

Compliance is key, as you want peace of mind that your employer will meet the standards set by HMRC. Some contractors look for this from the outset to inform their choice of umbrella. And although umbrellas are unregulated, some umbrellas have accreditations, from industry bodies like the Freelancer & Contractor Services Association and Professional Passport.

It is increasingly likely that your agency or end-hirer will have a PSL/ASL of umbrella companies on which they have completed their own, often extensive, ‘due diligence.’ While this can be viewed as restrictive, it can be positive providing compliance is the key driver.

If you are unhappy with one of your agencies’ approved suppliers, you should communicate this to your agency urgently, particularly if this relates to compliance as this could put them and the rest of the supply chain at risk.

Aside to compliance, ask some questions (and maybe your old accountant too)

Once you are happy with the compliance credentials of an umbrella company, next get an idea of the support they provide to their employees. Some questions to ask:

• What additional benefits do they offer above statutory entitlements?
• Can you elect to have employer’s pension contributions made into your existing pension pot?
• Will they be open always, or online-only at certain hours, when you need to speak to them?

If you have an accountant from your limited company days, ask for their advice too. Many of us accountants have been around a while and may even have an existing relationship with an umbrella company that could make transitioning between limited and umbrella working easier.

Finally, what NOT to do

Shopping around for the best take-home pay is not the way to go. All bonafide and compliant umbrella companies will be making the same deductions, with the only difference being the margin retained and potentially the basis of your workplace pension contribution.

While it may be unfamiliar, transitioning to umbrella employment does have some benefits. But don’t leave it until the last-minute. However do consider speaking with your current accountant, end-hirer or recruitment agency if you’d like some initial insight and even a practical leg-up when it comes to choosing a compliant umbrella employer, as such parties might be able to assist with the switch so you can continue working on your assignment, and future assignments, seamlessly.