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Umbrella companies, IR35 compliance & HMRC approval – contractors should be cautious

Contractors should be cautious of umbrella companies that claim IR35 compliance, HMRC approvals and special expenses dispensations, as such services providers are not being entirely straightforward with their marketing messages.

Umbrella service providers fulfil a vital role in the contracting supply chain, ensuring a suitable trading vehicle is available for contractors seeking a short-term contracting solution between permanent jobs, those who do not want to start and run a limited company, or others who may be in a contract which they know to be inside IR35.

However, some umbrella companies make claims in their marketing materials and sales pitches which are at best misleading and at worst should be complained about to advertising regulators.

IR35 is irrelevant to umbrella company contractors

Some umbrella companies claim that by using their services, contractors will remain ‘IR35 compliant’.

To put this into context, limited company contractors use the phrases ‘not caught by IR35’, ‘outside IR35’ and ‘IR35 compliant’ to describe their status when the legislation does not apply to them, and they pay less income tax and National Insurance Contributions (NICs) accordingly.

Similarly, limited company contractors say they are ‘caught by IR35’, ‘inside IR35’ or ‘not IR35 compliant’ to indicate that the IR35 legislation does apply to their current contract, and they pay more income tax and NICs, as if they were employed.

But in fact every contractor who uses an umbrella company is an employee of that umbrella company and pays income tax and National Insurance as an employee. In other words, IR35 is totally irrelevant to umbrella company contractors. In fact, umbrella company contractors pay a similar amount of tax to limited company contractors who are ‘not IR35 compliant’.

So any umbrella company claiming to be different from other umbrella companies because it is ‘IR35 compliant’ is not only likely to be being misleading, but is also getting the terminology the wrong way round.

HMRC do not approve any service providers

Umbrella companies can be fully compliant and follow tax, employment and company law to the letter, including any HMRC guidelines and recommendations. Indeed, some umbrella companies work closely with local HMRC inspectors and central HMRC compliance departments to ensure their processes and procedures are compliant.

Some umbrella solutions providers adhere to voluntary codes of conduct, such as those of the Freelancer and Contractor Services Association, as well as scrutiny by external auditors, the results of which are sent to HMRC.

But HMRC has not bestowed any special status on any contracting service provider or umbrella company and does not ‘approve’, ‘certify’ or ‘accredit’ any specific service offering. In fact, HMRC does not approve any service providers of any kind and is not allowed to do so, having to maintain its supplier-neutrality and not confer an unfair commercial advantage on any one firm.

Dispensations granted to umbrella companies do not confer special status

Contractor service providers sometimes use dispensations as a marketing tool and claim that, because the service provider has been granted a dispensation, contractors can automatically claim expenses without needing to keep receipts. Some claim contractors don’t even have to incur the expenditure in the first place, but have a right to claim it because of the dispensation.

This is not the case. By failing to keep expenses receipts, contractors could land themselves in considerable trouble with HMRC if investigated and asked to provide proof that expenses have been incurred solely for business reasons.

A dispensation merely relieves the need for an employer, such as a contractor limited company or umbrella company, to provide an individual P11D for every employee to account for the reimbursement of expenses where there is no tax to pay.

Dispensations can be granted to any business that can demonstrate some form of audit oversight. Increasingly, contractor limited companies are being granted dispensations, so contractors should be particularly wary of umbrella companies that claim special status because of an HMRC dispensation.

Contractors choosing umbrella companies should complete due diligence

If a contractor has fully investigated the trading options available for contracting, and has decided the umbrella route is for them, then due diligence is essential.

Contractor Calculator’s free Umbrella Cost Checklist identifies the factors to consider and the questions to ask any potential supplier when choosing an umbrella company. The checklist will help contractors identify umbrella companies that are making marketing claims that have little relevance or could even be misleading.

For many contractors, an umbrella company is the ideal trading vehicle, but it is important that they choose an umbrella company on the basis of the service they provide.

Published: 31 January 2011

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