A new umbrella company scheme has been exposed that could leave contractors facing huge tax bills. The scheme was uncovered by ContractorCalculator, after investigating an unusual contract and payslip from a public sector contractor working through an umbrella company.
This is not the first dodgy tax handling procedure that umbrella companies have adopted since the changes to IR35 in the public sector, where the problem is intensifying. More contractors are hedging their bets on non-compliant umbrella providers to help recoup earnings lost through the draconian reforms.
How does the umbrella scheme work?
The scheme involves issuing advance gross payments that are taxable at a later date to its contractors, disguising them as bonuses without informing the contractor that tax is due.
The contractor receives payment in two parts. A sum is recorded as salary and subject to Pay As You Earn (PAYE) income tax and National Insurance Contributions (NICs). Meanwhile, another lump sum is paid to the contractor as a ‘taxable discretionary bonus’.
This is actually an advance and isn’t taxed at source by the umbrella company. However, critically neither the umbrella nor the agency clearly point out in advance that the contractor will be liable for tax at a later date.
“What the agency and umbrella has told the contractor is that working in this way will be more tax efficient than running a limited company outside of IR35,” says ContractorCalculator CEO Dave Chaplin.
“This particular umbrella company operates by asking the contractor to state their desired take home pay, say 79% of their gross income – with the umbrella company engineering the payslip to allocate a lump sum as a ‘bonus’.
“This gives the impression that the contractor has achieved their desired income, but it fails to point out that the bonus will be subject to tax. What’s worse is the umbrella company was recommended to the contractor by their agency.”
According to Adrian Marlowe of Lawspeed, which specialises in providing legal and business services to the recruitment and contracting sectors, “We have seen firms like these make dubious claims on their websites as to who has accredited them. Legal and tax firms in the contracting sector need to be careful how their firms names and reputations are being used without their permission, and contractors would be wise to challenge any such claims and ask for proof.”
Is the rise in non-compliant umbrellas down to IR35?
This is the latest in a line of dodgy umbrella schemes that have become more prominent since the implementation of the public sector IR35 reforms last April, as CEO of the Freelancer and Contractor Services Association Julia Kermode points out:
“We warned HMRC that this would happen. Contractors are always looking for the best deal, and many are being enticed by umbrellas promising a high return on their income. These contractors need to remember that it’s not the scheme promoters who HMRC will go after for unpaid tax and NICs, it’s them.”
Kermode also warns of schemes whereby contractors receive payment in the form of annuities and redeemable loyalty points, both of which are being targeted by HMRC.
As Chaplin highlights, a lack of understanding of tax law could prove costly for some contractors: “These schemes are cropping up all over the place in the wake of the IR35 reforms, and contractors without a firm grip on tax law are being misled into using them. They simply do not work and contractors are strongly advised to avoid them.”
Characteristics of a non-compliant umbrella company
“There is simply no way any compliant umbrella firm can offer a tax saving better than using a limited company operating outside IR35. It doesn’t exist,” continues Chaplin. “The agency involved was completely incorrect in making this claim, and clearly doesn’t understand tax law.”
The promise of unrealistic tax savings should provide a clear indication that you are dealing with a dodgy umbrella company, although there are other warning signs, as Kermode highlights:
“Compliance rarely comes cheap. Some umbrellas can run compliant, efficient operations off low margins, but in most cases it’s a case of ‘you get what you pay for’.”
Kermode also encourages contractors to question any umbrella provider whose terms of payment deviate from the standard PAYE format: “If a payslip includes anything unconventional at all, ask the provider about the tax and NICs implications. If you’re not happy with the explanation, don’t go with the umbrella.”
How to make sure your umbrella company is compliant
To ensure your umbrella provider is taxing you appropriately, you can input your daily or hourly rate into ContractorCalculator’s Umbrella Calculator and compare the result against your income. Regardless of the umbrella that you use, your post-tax income should remain consistent, the only possible variants being your expenses and the umbrella margin.