Contractors' Questions: Will being inside IR35 trump using a brolly?
Contractor’s Question: Assuming my public sector client or agent declares me inside IR35 from April 2017, which of the following is going to be more tax-efficient; keep my PSC and declare inside IR35 with the associated tax obligations or join an umbrella company and serve my client as a brolly contractor operating the brolly’s PAYE?
Expert’s Answer: It depends! It always depends on your personal circumstances and your financial goals. If tax-efficiency is your only driver then under current rules it is more beneficial to operate through your PSC inside IR35.
Under the deemed salary payment rules your tax liability will be calculated on 95% of your company’s income, rather than 100% of earnings through an umbrella company. This is due to the 5% allowance given to help with the running costs of the company which will include items such as professional advice, professional memberships and training costs.
What we don’t know right now is what the rules will look like from April 2017. HM Revenue & Customs is consulting on the proposal to move responsibility for the calculation and deduction of the deemed salary tax to the public sector engager or agent. As part of their discussion, the future of the 5% allowance is also under review and its removal would clearly represent a reduction in tax-efficiency for a PSC.
However, what will remain is the ability to make pension contributions. Larger and more flexible contributions are available to a PSC contractor than to an umbrella employee and these represent an opportunity for greater overall tax-efficiency. These pension costs are deducted from the company’s earnings before the deemed salary calculation is applied and so further reduce a contractor’s personal liability.
In addition, although travel and subsistence expenses are no longer allowable through a PSC inside IR35 (neither are they available to an umbrella employee found to be under Supervision, Direction or Control), a PSC still has access to a wider range of allowable expenses such as use of home and an annual staff entertainment allowance.
A PSC contractor also has the ability to increase take-home pay through the Flat Rate VAT scheme, which is unavailable to umbrella employees. This can add around £2,000 - £3,000 per year to a PSC’s turnover.
Finally, it is worth bearing in mind that tax-efficiency is not the only factor when deciding how to undertake your next contract. PSCs offer autonomy and the opportunity to be your own boss with a more flexible work-life balance. Running a company comes with the legal responsibilities of being a director, but the benefits of greater control and in some sectors conveys a more professional image. Umbrella companies offer the security of continuous employment and all statutory employment rights. The contactor has no obligation to file year-end accounts or returns and for many they are an easy and efficient way to be paid with few worries.
The expert was the Freelancer & Contractor Services Association (FCSA).