If you are entering into a contract with an agency you will no doubt have been faced with the daunting options of choosing your route – either going PAYE directly with the agency, going limited or using an umbrella company.
From our discussions with contractors, many are still unaware of the what each option actually means to them and what, if any, the risks are to them.
Agency
Working directly to the agency is by far the simplest and safest route open to contractors. You get paid by the agency for the hours you work, everything is taxed and Ni’ed at source, you get holiday pay and statutory sick pay etc. so what hits your bank is yours and you don’t have to think about anything else.
The downside is that due to legislation the agency has to pay you PAYE and you cannot claim travel expenses week by week, as although you suffer the Tax and NI consequences as though you are an employee, you don’t get the advantages of employee expenses rules.
Umbrella
The umbrella route is fairly straight forward, you are an employee of the umbrella company, as such you are entitled to national minimum wage and holiday pay for every hour worked. You can also claim genuinely incurred travel expenses, and will usually receive a top up salary if there are any monies left in the umbrella company after it has accounted for its margin and company costs.
In addition, as an employee, you are entitled to all the statutory rights of employees, such as maternity pay/paternity pay, statutory sick pay etc
The risks to you here are fairly minimal, however you must be aware that only those expenses incurred wholly, exclusively and necessary in the performance of employment duties can be legitimately claimed, and if the Revenue were to check it is you, not the company, who are liable for tax and NI on incorrectly claimed expenses. Every contractor should be extremely cautious of umbrella companies encouraging them to simply “shove through” expenses as they could be hit with a hefty tax bill when they least expect it.
Does low risk outweigh the benefit? Quite often unless you have a rate of £10 per hour or more and do a lot of travel for your job then working directly for the agency may be your better option, as unless there is scope to pay you significant travel expenses from the monies received by the umbrella you will not see a substantial difference in your take home pay.
If you do have a significant amount of travel expenditure and your rate is sufficiently high then the benefit in your pay will be substantially noticeable.
Self-Employed Umbrella vs Limited Company
There seem to be a lot of misconceptions among contractors as to what it means to be self-employed, and the risks and burdens associated with being self-employed. Many contractors think that being self-employed means the Revenue will be watching them, that they will have to jump through a ridiculous amount of hoops and that they will end up with a raw deal.
The stigma surrounding self-employment is somewhat unjustified, and many contractors opt to work through their own limited company instead under the misguided notion that it is somehow a “safer” and less “burdensome” alternative.
Burdens – So what are they?
1. As a self-employed individual you must complete a tax return and account for your own tax and NI – True.
As a limited company contractor you would also need to complete a tax return, but on top of this you would need to set up a company and company bank account, register as an employer and ensure your PAYE and NI is calculated and paid across correctly on an ongoing basis for any salary paid out, complete a corporation tax return, file accounts and submit an annual return to companies house.
2. As a self-employed individual you can only claim your expenses back at the end of the year – True – but this only affects the tax due, not what you are paid weekly/monthly.
As a limited company, providing you were also an employee of your limited company, you could reclaim expenses providing they meet the criteria for employee travel expenses, and/or reclaim business on an ongoing basis, however they would still need to be entered on your end of year return/P35 – depending on the expenses reimbursed a P11D and P11D(b) may also need to be prepared.
3 As a self-employed contractor you don’t get holiday pay, sick pay, maternity pay etc and can be terminated at any time.
As a limited company contractor you don’t get holiday pay, sick pay, maternity pay etc from the client and you can still be terminated at any time.
So is it really a burden to be self-employed?
Safer?
As a self-employed individual, who has completed their tax return correctly and paid across their tax and NI there is no risk. If the Revenue were to question whether you are genuinely self-employed it would be the engaging company (the self-employed umbrella) who would be directly in the frame for any liability of unpaid tax and employers’ national insurance. You would not be hit with any further tax bill.
As a limited company contractor, who has completed their accounts and returns correctly and paid the due you would assume there is no further risk, this is simply not true. The Revenue can challenge the company under IR35 (which considers whether, hypothetically, you are a deemed employee of the end client) and it would be your company, not the provider or end client, who is in the frame for liability of TAX and NI. You would be hit with the tax and NI bill.
While limited companies are suitable for a great many contractors, equally they are not suitable for a great many more. They are certainly not the answer if you are worried about self-employment and want a safer alternative. In most cases, as an individual, self-employment is a far safer option than the limited company and it gives you the freedom and flexibility of being independent (which you don’t necessarily get with the umbrella option) without the hassles of running your own limited company (or the worry that your limited company could be a managed service company – a whole other legislative can of worms best avoided).
The risks to the contractor of being self-employed are negligible, the only liability an individual could face is if they incorrectly complete their end of year return, but a decent accountant is not as expensive as many people think and 90% of contractors still benefit from receiving more income than they would have as an agency worker even after paying for accountancy fees.
Limited Company – What are the benefits? What are the risks?
Going limited is a common option open to contractors, the benefits are highly publicised, the contractor can take his income as a small PAYE’d salary (typically up to Personal Allowance) and tax free employee expenses and the remainder by way of dividends out of the company profit, (however the company has had to pay corporation tax 21 % on all profit). This gives the contractor a huge benefit in tax free income (compared to all other models).
Generally speaking if the only reason you are looking at this option is because “someone said you should” or the agency is pushing you that way, common sense dictates this is not an option you should pursue. If you are interested in going limited, speak to professionals, seek advice from your accountant and look at it as an option because you are growing as a business and need a limited company to secure future business, because the risks of just jumping into limited are significant.
There are two huge risks associated with going limited, the first is IR35. IR35 essentially says, hypothetically speaking if we remove the limited company, if the individual were engaged directly by the end client would they be an employee. The upshot of this, if HMRC were successful, is that the limited company would be liable to pay Tax and NI on all divided payments made. This liability rests squarely with the limited company, so the unwitting contractor could see himself lumped with a massive tax and NI bill unexpectedly.
The second biggest risk is the Managed service company legislation. If you are operating through a limited company which is set up, administered and effectively controlled by a provider, and you have little or no control over your company then your company is almost certainly a managed service company. As such if HMRC come knocking for Managed Service Companies legislation it is your company (and potentially you personally), not the provider who set it up for you, liable to pay the Tax and NI on all dividend payments made.
So Which option is best? PAYE or own boss?
This really depends on what you want, generally speaking all options work, but as with everything not all options work for all people. If you are unlikely to keep papers and put your tax to one side neither Limited company or self-employed will be suitable, and if you are a low earner and don’t have reasonable level of expenses the umbrella would likely not be your best options. If however you are after the lowest risk option to you, the contractor, then agency or self-employed have to be your best option.
About the author: David Harmer
David left Accountax as Operations Director in December 2010 where he regularly defended clients against HMRC attack up to and including tax tribunal level. He was a much sought after umbrella specialist and in January 2011 he set up Marble??, an umbrella company providing a 100% compliant service to contractors.
David Harmer. Director, Marble Commercial Contracting
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Image: Decisions by katietower
