April 2007 saw the most significant tax changes for contractors since the introduction of IR35 seven years previously. Since the Treasury announced its publication ‘Tackling Managed Service Companies’ in December 2006 there has been much confusion and anxiety. The loophole that allowed contractors to work through certain managed service companies (MSCs) has been closed and information technology, engineering, healthcare and other contractors must now carefully consider their options.
Historically, the majority of contractors worked through their own limited companies. The tax advantages of working this way far outweighed any other methods. But with the introduction of IR35 the main tax advantage (where contractors paid themselves dividend rather than a salary) has been removed depending on whether the contractor falls within the new IR35 rules or not. Contractors genuinely in business on their own account and operating through a limited company have nothing to fear.
All forms of MSCs that work as intermediaries in an effort to avoid tax will now be carefully scrutinized by HMRC – which has designated extra offices to handle such investigations.
Contractors should act now. The options are to run a limited company (and be genuinely self employed), use a reputable umbrella with its own payroll solutions or be PAYE through an agency. Basically, as a general rule, if you fall outside the IR35 rules then you will probably be better off using a limited company, whereas an umbrella company would probably be more beneficial otherwise. While some agencies allow contractors to be PAYE through their own payroll service it is the least tax beneficial option as full tax and NIC are paid and there is no option to claim valid business expenses to reduce this. Sole traders can only operate if they find their own clients, and do not use an agency.
IR35 legislation has not changed and all contractors must still consider whether they are inside or outside it. To be outside IR35 a contractor must be genuinely self-employed and meet the HMRC definition of self-employment. Reputable umbrella companies generally remain outside IR35 because they operate a PAYE system.
There are important considerations when deciding to form a limited company or use an umbrella payroll solution. By forming a limited company a contractor remains in control without having to deal with third party administrators. The contractor is responsible for running the business and it is the most tax efficient way of working. There is more paperwork and various company law and other requirements must be met. But forming a company is fast and relatively straightforward.
Contractors who sign up with an umbrella company will be under PAYE and will no doubt have less paperwork and hassle. Respectable umbrellas will keep consultants outside IR35 by scrutinising the contracts, offering IR35 insurance and operating PAYE. The main disadvantages of using umbrella services are that it is an expensive way of working in terms of tax and NIC and the contractor is reliant on the umbrella company to collect the money from the client or agency and then forward it on.
Contractors should remember that it is the contract that determines IR35 status and each contract should be considered on its own merit; it is possible to be inside IR35 for one job and outside it for another. HMRC also plans to pursue “appropriate third parties” which have gained from the provision of working with MSCs and claim tax benefits. These will include recruitment agencies which will therefore need to implement new strategies to vet contracts and check the status of workers.
Some umbrella companies make reckless claims about expenses, but the new legislation has removed the high level of expenses claimed previously. Contractors working though umbrella companies will now need specific accurate records for genuine business expenses.
Use the Duport site to read about the legislation in more detail, to weigh up the advantages and disadvantages of all the options and to understand employment status and contracts. There is also a detailed section which explains the most frequently asked questions. Also, customers can contact the office for further advice.
