Myth v Reality
There’s no doubt about it, the UK tax system is very complex (all 14,000 pages of it). Given this background, it is not surprising that an army of tax lawyers and accountants is able to find loopholes in the tax system that may or may not turn out to be legal (there’s certainly been no shortage of cases involving household names recently!)
Whilst these arrangements are given labels like “HMRC compliant” or “QC approved” many turn out not to be and the fact is that HMRC does not approve any individual schemes whatsoever, it simply clamps down on those, sooner or later, that it does not believe are compliant with the guidance.
The regulatory environment is getting even tougher recently, with the government and HMRC clamping down harder on tax avoidance schemes across the board.
Some aspects of the tax code are clear – the basic rate of income tax on earnings is 20% and once you earn more than about £45,000 pa, this increases to 40%. Above £150,000 this rises to 45%. All paid ‘earnings’ also attract national insurance on top of these income tax rates (dividends do not currently attract national insurance, which is one reason why limited companies are genuinely more tax-efficient in many cases).
So, when a scheme offers you the ability to take home 80%, 85% or even 90%+ of your earnings as take home pay, this by definition, must be using some sort of tax avoidance scheme to achieve this. HMRC simply do not allow tax percentages to be this low and they certainly do not ‘approve’ such arrangements. They cannot be accurately described as ‘compliant’ unless they have been individually investigated, tested in court and found to be legal. This is not a process we would recommend.
Any scheme that does not operate using the standard PAYE arrangements, is at best at risk of being found illegal or non-compliant and where found to be, anyone using such a scheme will be liable for significant amounts of retrospective tax and national insurance, plus interest and penalties. At the very best, such investigations can take years to come to conclusion, meaning no certainty over your income and a whole load of hassle in the meantime.
These schemes are often not really umbrella companies at all but offshore tax avoidance schemes but the way they work is not described and the providers take huge fees. For example, if the promised 80% or 90% is paid to you the contractor, it is likely that the lion’s share of the remaining 20% or 10% has gone to the provider and a very small percentage in tax, since the scheme has been set up to pay virtually no tax at all. That is why they are prepared to take the risk. By contrast, for a contractor earning £20 per hour and working a 35 hour week, our fees equate to less than 3% of your gross earnings.
If you do sign up with one of these companies and it proves not to be compliant in the long term, as several have (even those backed by opinions from the ‘Big 4’ accountancy firms) you are likely to face the following:
- A large backdated tax bill for all the tax and national insurance you should have paid
- A long period of uncertainty and hassle, while the scheme is investigated, often several years
There are numerous cases of contractors who have found themselves in this desperate position, often because the facts have simply not been explained to them. Please ask yourself, is it worth the risk – everyone has to pay tax, it’s just a fact of life.
Some common claims and myths from some umbrella or payment solutions companies:
Umbrella companies can decide what tax you should pay and how much you take home:
All companies have to abide by the UK tax laws and guidance. They cannot influence how much you tax you should pay. How much you money take home depends solely on how much you earn, what your genuine, work-related, evidenced expenses are and how much the company charges. Nothing else. So, one company cannot offer you a higher take home pay than another and still be compliant – two genuinely compliant companies, charging the same margin, will pay you the same amount!
If they offer higher take home pay, this can only be because they charge a lower fee (and they should be transparent about the pre-tax cost of this fee), or because they are operating a scheme that is not compliant with PAYE rules.
An umbrella scheme or solution is “HMRC approved” or “fully compliant”
HMRC do not approve ANY individual schemes. They just regulate the legally enforced tax regime and investigate those arrangements they believe are not compliant. The only way to be fully compliant, without risk is to comply with the core tax rates under PAYE arrangements, no matter what any number of lawyers or QCs might say about a particular scheme.
As an employee under a PAYE umbrella scheme, you are only allowed to claim the value of any expenses that you have actually incurred, that you can prove you have incurred and that you have incurred wholly and exclusively in the course of your work and only where these were not reimbursed to you.
You cannot claim ‘round sum’ allowances per day, if you have not incurred any actual costs.
Therefore, please remember that whilst claiming expenses against your income will save you 20% or 40% of the expense value in tax, you have had to actually incur the whole expense in the first place – paying £100 a week to travel to work, not reimbursed as part of your contract, will still cost you a significant percentage of the £100.
A good umbrella company will advise you as to what expenses can legitimately be claimed and stop you from claiming those that would be disallowed by HMRC if they were checked.
Claiming for travelling to work
You can only claim for expenses relating to travelling to work if there is a reasonable assumption that you will be employed by the same company for more than one assignment and that you will not be working at your current location for less than 24 months. To comply with this, your umbrella company must employ you under an ‘over-arching’ contract that employs you between contracts, not just for the duration of one contract (or else this would just be deemed a permanent place of work).
Tax calculators provide an accurate view of what you will actually take home
There are only a few variables that affect how much tax you need to pay and how much money you take home – your gross pay (daily rate x amount of time worked), the value of genuine work-related, HMRC-eligible expenses you have incurred and the margin a company charges. Your umbrella company can only affect the last of these.
Unless you know and you are asked to enter the specific amount of expenses you expect to be able to claim into an online calculators, using it will not tell you how much you will earn using a particular company, as they will have simply assumed a level of expenses that may be nothing like what you really incur, to artificially reduce the amount of tax you’ll pay.
For two compliant companies, charging the same margin, you should get paid the same amount anyway. The umbrella company cannot reduce your tax paid by being ‘clever’ with your expenses. It can pretend your expenses will be higher than they will be, meaning you’ll be disappointed when you get your payslip, or they can claim expenses in a non-compliant manner, exposing you to the risk or a large tax bill. Otherwise, it’s the same tax bill, wherever you go!
HMRC “dispensations” mean you pay less tax
When an umbrella company says they have “HMRC dispensations” all this means is that they have an exemption from listing all of the individual expenses on some forms they file with HMRC once a year. It does not mean you can claim more than with any other company that does not have a dispensation, or that you can claim any expense that you have not genuinely incurred.
IR35 relates to individuals operating as self-employed or using limited companies. It does not have anything to do with people employed under PAYE via an umbrella company.
An umbrella company cannot be “IR35 compliant”, only an individual employment arrangement can be.
Saying an umbrella company is IR35 compliant means nothing. However, using a PAYE umbrella company solution does mean there is no risk of falling foul of IR35 rules and these do not have to be considered, compared with the limited company option.