In the UK, more and more professionals choose to contract. Contracting is actually a viable way to earn a good income compared to traditional employment. Aside from the earning potential, it is considered by most because it is the most tax efficient way possible.
Introduction to contracting
A contractor refers to a person who agrees to provide his/her expertise to a company to accomplish a particular project – often within a fixed period of time. Contractors are often called freelancers. Instead of receiving a paycheck at the end of the month, the contractor usually invoices the company for his/her services performed.
During the 1980s, contractors played a major role in the rise of IT especially in the world of business. The growth inspired businesses to source skilled labor from other countries. This is when umbrella companies come into the picture. Umbrella companies are helping contract workers make a smooth transition while there are other companies that offer accountancy services like Contract Tax Calculator to ensure that the contractors are not paying any more tax.
How an umbrella company benefits contractors
Many contractors contract through limited companies as this is the most tax efficient way. However, for those who do not want to deal with the paperwork prefer an umbrella company. Umbrella companies are created to remove all administration and company management. Basically, it presents a hassle-free way of outsourcing your payroll.
What to expect in an umbrella company solution
If you are a contractor, the umbrella company solution will take care of all the accountancy and taxation matters including administration tasks. You will complete a timesheet and forward it to the umbrella company. Upon completion, the company will invoice the agent. Following payment by the agent, a payment will then be sent to you.
Your income will be treated as the salary. This means that you will pay employers NI, employees NI, and PAYE. You have to be cautious though because there are some companies that offer large take-home pay, which is not IR35 compliant.
Understanding IR35 issues with umbrella schemes
You have to understand that any payment structure (whether limited or umbrella company) does not influence IR35. IR35 is a tax legislation created to tackle tax avoidance by workers that are supplying services to clients through intermediaries (limited or umbrella company).
These workers are called “disguised employees” by HMRC. If caught, the contractors will have to pay National Insurance Contributions and income tax as if they are regular employees. Many try to avoid this because its financial impact is significant – it can reduce the worker’s net income by up to 25%.
IR35 was introduced to address “disguised employment” where organisations employ workers on a self-employed basis instead of offering employment contract. This act can save the organisation a significant amount of money as they do not need to pay NIC and it also means that they do not have to offer any employment benefits or rights. The legislation has two goals – defend the worker’s rights and recover lost tax yield.
Now you know more about umbrella companies and the punitive IR35. When choosing an umbrella company, there are many factors that you need to consider as a contractor. Take time to think about it before you dive right in.