Umbrella or PSC inside IR35: which is better?

Public sector contractors are probably really confused right now. Clarity and IR35 have never been good bedfellows and the changes to the rules which came in April 2017 are no different. Muddying the waters further is experts not agreeing, writes Helen Christopher of Orange Genie.

For example, this article says a brolly is financially better if you’re caught by IR35 from next month in the public sector; this follow-up article says that being a limited company and operating IR35 is better.

Public sector contractors

Assuming an inside IR35 decision has been given, the contractor has one of two choices (assuming we accept that they take up the contract and do not seek an alternative): PSC inside IR35 or transfer to an umbrella company.

Take-home pay

Much commentary surrounding the decision to use a PSC or umbrella model focuses on the impact on take-home pay. If take-home is the key deciding factor for a contractor, then a public sector-only worker on assignments inside IR35, is likely to be better off in an umbrella model (subject to the umbrella’s margins), as the below table shows.

Day Rate PSC (outside IR35) PSC (inside IR35) PAYE Umbrella Employment
£200 £3,243 £2,820 £2,896
£300 £4,638 £3,940 £4,000
£400 £5,852 £5,060 £5,104
£500 £6,908 £5,890 £5,991
£600 £7,869 £6,908 £6,946
£700 £9,803 £7,981 £8,006

Assumptions: 1150L; Monthly pay frequency; No expenses; [email protected]%; No pension contributions. Apprenticeship Levy uplifted in rate.

The take-home pay for the PSC, inside IR35, is likely to be less than the umbrella take-home, given the loss of the 5% deduction for general company running costs and the additional PAYE and employees NIC that will be payable on the deemed salaries. A further reduction will also occur where the PSC falls into the definition of a ‘Limited Cost trader’ under the changes to the Flat Rate VAT scheme in April: where these apply, the flat rate will be 16.5%.

A further consideration for contractors operating in a PSC inside IR35, will be the effect on their cashflow based on the definition of the deemed salary calculation to be run by the “fee-payer”. The fee-payer, likely to be the agency, end-client or third party, will be obliged to apply PAYE and employees NIC to the deemed salary calculation. As it stands, the legislation tells them to apply a BR tax code (a BR tax code taxes all income at basic rate, 20% ignoring any personal allowance and assuming that you have more than one job). While claims for relief in relation to allowable expenses and pensions can be made on self-assessments, this will happen sometime after the financial year-end and will leave contractors severely disadvantaged on a monthly basis compared with being an employee of an umbrella company, where the correct tax code will be applied to each payment.

Other considerations

When choosing the best solution post-April 6th 2017, a PSC contractor may also be concerned with the loss of other perceived benefits of running a limited company that were so important to the PSC owner at the time they incorporated.

Limited liability protects against the risk of personal liability and is often cited as a key reason to form a company. The same protection is available through being an umbrella company employee, where personal risk is covered through Employer's Liability insurance. Umbrella employment also allows flexibility and freedom to choose which contract to take, when and where to work, much the same as through a limited company.

Running a limited company has some kudos. Directors have an elevated status compared to employees, but they also have responsibilities and additional risks. Under the new rules the PSC inside IR35 will retain the responsibilities and risks but will suffer PAYE and NIC as an employee. No additional employment or statutory rights will be afforded to the contractor deemed to be an employee, so given that take-home is also likely to be higher in an umbrella model, we believe that this is the more attractive option for public sector, inside-IR35 contractors.

No one-size-fits-all

It is vital that the contractor industry (including clients) works together to ensure that contractor assignments are correctly identified as inside or outside IR35. It has never been more important for contractors to understand their IR35 position and to be able to articulate this with their end-clients.

While we believe that umbrella is best for public sector workers, inside IR35, we recognise that some contractors will have genuine and unique reasons as to why they wish to continue to be paid via their PSC. The market has adapted to this and models are in place to allow this to happen.

What is apparent is that one solution does not suit everyone. Contractors should speak with their accountants and advisers as soon as possible to establish the right route for them.

Tuesday 22nd Jan 2019
Profile picture for user Helen Christopher

Written by Helen Christopher

Chartered accountant Helen Christopher is a former head of finance & accounting and a former chief operating officer, who has worked for 28 years in corporate roles. Helen qualified as an accountant in 1995 with Price Waterhouse (now PwC) – the year she became a member of the ICAEW, and seven years prior to her becoming an FCA. Also a local magistrate for the Department of Justice, Helen specialises in tax, accounting and HMRC advice for small companies and their owners. 
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