Dear Contractor Doctor,
I work for a telecoms company as a permanent employee and am on three months' notice. There is an opportunity for my permanent role to be replaced in the Finance department with a contract role in the IS department.
Do you know if there is any employment/tax legislation which mandates that I must leave the company for a certain period before I can return as a contractor.
Thanks for your help.
Contractor Doctor says:
There are no laws against this at all. However, there might be internal policy which states that an employee who leaves cannot come back for a set period. The main concern though would be IR35 issues - a tax law that could cost you a significantly higher portion (circa 20%) of your contractor earnings in tax compared to contracting elsewhere.
This type of activity where the employee leaves the company on a Friday as a permanent employee and returns on the Monday as a contractor was referred to as the 'Friday to Monday' situation when IR35 was first proposed in 1999. It was this type of activity that the Government introduced the legislation to prevent.
The reality though was different to how HMRC perceived it. Back in 1999, IT developers were in very high demand, commanding rates equivalent to twice what they get paid now. So most programmers decided to cash in on this market and leave where they were working and become an IT contractor. Employers who wanted to retain their staff had little option but to either give them an enormous pay rise, or to allow them to transition from being a permanent member of staff to a contractor, with no real change in their job. Many choose the latter.
So, whilst the IT workers were paid considerably more as a contractor compared to their previous salaried job, and therefore generated more tax for the Treasury, HMRC didn't see it that way. And they still don't. Instead, HMRC made the decision to raid the lucrative IT sector, by claiming that workers were leaving their jobs on a Friday, returning on a Monday as a contractor, with much less tax being paid. But this wasn't actually true.
HMRC's argument was that this Friday to Monday strategy was attractive for employers and employees, since the employers saved money since less Employers NI was paid. The Employee (now a contractor) loses many employment rights since they work through a limited company, but they also get more money in their pocket since their taxes reduce due to lower employers NI payments and the advantages of operating through a limited company structure. But that's not the whole story.
The truth is that contractors charge more than salaried employees doing the same kind of work, and therefore generate more in tax revenues compared to the equivalent permanent employee. But HMRC refuse to acknowledge this, because their flawed thinking underpins the reasoning behind IR35 existence.
But IR35 is here to stay, and if you are caught you still pay a large amount of taxes, since you the contractor pays all the employers NI that would have been paid by the company. So HMRC still get their money, but you get no employment rights at all.
Suffice to say, it is worth ensuring you do not get caught by IR35.
For cases where the employee continues to do the same job as when they were permanent this could prove very difficult, because HMRC will argue that the contractor is a 'disguised employee' and under the IR35 tax legislation must pay tax as if they were an employee.
The ideal situation is to take a break of a couple of weeks after leaving the client, and then engage with them on a service basis. For this specific situation we recommend contractors have a thorough IR35 contract review and also take out IR35 tax insurance.
Good luck contracting!