Dear Contractor Doctor,
I am an IT contractor and work via my own limited company. I pay myself a low salary and dividends. I became unable to work due to illness and do not foresee being able to work in the near future. As a result, I started the process of claiming Employment and Support Allowance but have now been told by HMRC that as a company director I am not eligible for any payments until after 28 weeks. In the interim I have been told I should pay myself sick pay from my limited company.
Having looked into this, my accountant tells me that any payments cannot be reclaimed from the taxman. So it seems that I can neither reclaim any payments through my company nor receive any help from the Government for 28 weeks.
Please can you tell me if this is correct and, if so, if there are any other avenues that I can explore?
Contractor Doctor says:
“Generally, if a contractor is out of work, they can claim Job Seekers Allowance (JSA),” explains James Abbott, owner and head of tax at contractor accountant Abbott Moore.
“However, being ill rules out this possibility as it means the contractor is incapable of looking for a job. As a result, alternative sources of income need to be explored, such as the Employment and Support Allowance (ESA).”
Change in HMRC policy removes protections for businesses
Abbott explains that the contractor will have been quoted 28 weeks by the Government because that is the time limit during which the ‘employer’ is responsible for payment of Statutory Sick Pay (SSP):
“That all sounds fairly reasonable in most circumstances, but the problem here is the contractor is forced to fund their own sick pay as they are drawing money from their limited company.”
Previously, small employers were able to recover some or all of the sick pay that they had paid out to employees from the Government. However, following a change in HMRC policy in March 2014, this is no longer the case.
Contractors have options providing they plan ahead
Whilst this scenario is far from ideal, Abbott notes that there are a couple of options open to contractors. Firstly, providing the contractor still remains a part of the company’s operations, they will be able to continue to draw a salary.
“The contractor may continue to be a director of the company, for example. Even though it may not be a full-time role, they can still draw a salary from the company, though they won’t be able to recover the money from anywhere else.”
Limited company contractors facing illness can also continue to draw dividends from the company, but only to the extent that they have the financial reserves in the company left over.
“Unfortunately, other than that, the contractor will have to wait for 28 weeks until the ESA becomes available, because technically their company no longer has the responsibility to cover their sick pay,” Abbott adds.
Risk-factor contributes to higher contracting rates
Having no safety net in case of illness is simply part of the risk that contractors take, one which contributes to the higher day-rates that they receive, compared with equivalent employees.
“What you’ll often find with contractors is that they will try and build up reserves inside of the company. Either that or they will save money personally, so that they are able to draw on those savings if they are unfortunate enough to require to do so.”
Abbott adds that an alternative solution would be for contractors to invest in critical illness cover, which acts as an insurance policy for contractors in a worst case scenario.
“Sometimes, being a contractor, you have to take the rough with the smooth,” Abbott concludes. “You get a greater income but there is the acceptance that you don’t always get the same support when things don’t go quite well.
“This makes it all the more important for contractors to plan ahead and look at the options available to them.”