Umbrella Company and IR35

Using an Umbrella company by companies increased rapidly following the Inland Revenue (now HMRC) issuing bulletin IR35. In simple terms, this bulletin announced proposed changes to tax law that reduced tax avoidance by people who worked as contractors rather than becoming a worker of the company they worked for. The bulletin has become widely known as IR35.

The introduction of the rules detailed in IR35 reduced the range for higher paid workers of businesses to set up as contractors (still working for exactly the same company) by setting up limited companies and drawing small salaries and taking most of the income as dividends, decreasing their tax and National Insurance payments.

Effectively, IR35 set up a series of tests to determine whether a person is a true contractor or perhaps a disguised employee of the company they’re working for (client company).

Each time a contractor agrees a contract having a client company, whether or not it is directly or via a recruitment agency, you will find risks that it may fall within the scope of IR35 and the contractor may be treated for tax purposes as an employee of the client company.

This really is where the Umbrella corporation comes into play. The contractor is (or turns into) an employee of the Umbrella company that will bill the client company (or hiring agency) for the many hours worked and any valid costs accrued. On payment being received via the Umbrella company they’ll compensate the contractor, deduct and take into account tax and National Insurance. The costs will probably be looked at when calculating the pay, tax and National Insurance for the contractor.

Contractors that acquire work through recruitment agencies have slightly different agreements. There are additional steps in the process that involves the agency is invoiced via the Umbrella corporation, the agency invoices and is paid off by the client company and the agency subsequently will pay the Umbrella company.

Contractors working for an Umbrella corporation can show that they’re not an employee of the client company and consequently don’t fall foul of the IR35 rules. The Umbrella company charges the contractor a flat fee for the provision of its expert services and this really is an allowed expense for tax reasons.

A good example of how a contractor is paid through an Umbrella company works is best shown as such:

Contractors who don’t work through Umbrella companies have to handle all the extra paperwork, deal with the invoicing and account to HMRC for tax and NI. Additionally they may face investigation pertaining to the breach of IR35 rules. Suspected breaches of IR35 rules are complicated and really expensive to defend. Even if you effectively show that you simply haven’t breached the IR35 rules, you can’t reclaim the expenses you’ve accrued.