Dear Contractor Doctor,
I've just started contracting and have registered with an umbrella company.
I would like to know if, as a contractor with an umbrella company, I am supposed to pay both the employee and employer NI contributions?
Contractor Doctor says:
Firstly, well done for taking the plunge into contracting!
Your question is a good one, and the topic of NI payments is one that many first time contractors need to address.
In terms of NI payments both Employers and Employees NI do need to be paid, but the question is by who? And where does this money come from?
These payments are processed by an umbrella company, if one is used. But, complications in terms of liability for funding the employers NI have arisen since the public sector reforms were introduced in April 2017. This issue is explored in detail in our guide Can umbrella companies deduct employer’s NI lawfully?. But we will summarise here
Historically it is worth noting that all advertised contract rates have been advertised at what we will call the "contracting rate". This is the rate that the agency sets aside to pay the contractor after they have charged the client a margin on top. The amount the agency charges the client is called the "client charge rate" - and it's not something they will normally reveal to you, and neither do they have to.
Again, historically, if you then decided to process all of your contracting income via an umbrella company then the gross fees would be paid to the umbrella company. They would then use that money to run a payroll for you, with them as your employer. So part of that money would be used for the employers NI component of the employment taxes, and any other employment taxes due by the employer - like apprenticeship levy, pension contributions and so on. This then leaves a calculated salary, which employees NI and PAYE income tax is deducted, leaving your net pay. So, for this scenario the employers NI contributions are indeed funded by your contracting rate.
Contractors operating outside IR35
In this instance the client pays the agency the "client charge rate", the agency deducts it's margin, leaving the gross fees payable to the contractor. These gross fees will be what has been advertised or agreed for the contract.
Because you have chosen to process all your gross fees via an umbrella company then the umbrella will use that money to run a payroll for you, with them as your employer, and all taxes, including the employer taxes will be funded by those gross fees. This includes employers NI, and other employment taxes like apprenticeship levy and pension contributions. This leaves you with a salary from which employees NI is paid and income taxes.
This is the equation for outside IR35 contracts:
Client charge rate = contract rate + agency commission (margin).
Contractor salary = contract rate - employment taxes (employers NI, levy, pension, etc.)
Contractor take home pay = salary - employers NI - income tax.
Therefore, for contracts that are outside IR35, in any sector, where the contractor choose to use an umbrella company, the employment taxes will be funded from the gross fees paid by the agency to the contractor's umbrella company.
In the public sector, for contracts that are pre-assessed and advertised as inside IR35 things are different are far more complicated.
How the public sector IR35 reforms change matters
Since April 2017, for contracts that are in the public sector and which have been pre-assessed as caught by IR35 and are advertised as "inside IR35", or "caught by IR35", or "IR35 applies".
Under this scenario, the legislation dictates that the "fee payer", in this case the agency, is responsible for paying the employment taxes, and then the deemed salary is paid to the contractors limited company. The deemed salary is defined as the amount the client pays the agency for the contractor, minus the agencies margin. [Note: This is actually called a "direct deemed payment" in section 61Q part 1 of the legislation, but for brevity we will called this a deemed salary.]
In this instance the "fee payer" is required to pay their employment taxes on top of the deemed salary advertised/paid to the contractor. The deemed salary is to then be processed, from which the employees taxes are deducted - employees NI and income tax.
So, the question arises, where is the agency (of fee payer) going to get the funds to pay the employers NI?
The answer is that this needs to be funded by the difference between what the agency charges the client, and what the agency pays the contractor.
A simple equation might make this easier:
Client charge rate = contract rate (deemed salary) + agency commission (margin) + employers NI.
Client charge rate: As a contractor, you are unlikely to know what this is.
Contract rate (deemed salary): This (should be) the rate advertised for inside IR35 contracts.
Agency commission (margin): As a contractor, you are unlikely to know what this is.
Employers NI: This is 13.8% on top of the deemed salary
Agencies that insist on contractors using umbrella companies therefore need to uplift the amount charged to the client, so that it encompasses all the employment taxes due on top of the advertised contract rate agreed with the contractor. Then the employment taxes collected are passed, along with the deemed salary, to the umbrella company. When processed, the contractor then gets paid a deemed salary which is equivalent to the rate advertised or agreed with the agency.
Agencies and clients should not be deducting their own employment taxes from the deemed salary payable to the contractor.
What if a limited company is used?
If a limited company is still used by the contractor, then the agency will pay all the employment taxes to HMRC, and then pay the deemed salary to the contractors limited company. The deemed salary should equate to the advertised rate or rate agreed with the agency/client.
What used to be a fairly simple aspect to understand has now significantly increased in complexity, due to the public sector IR35 reforms. Your best bet is to avoid taking any contract that is caught within IR35.