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IR35 Testing

Umbrellas, HMRC, and dispensation agreements

What is an umbrella company?

There are no national guidelines from a HMRC perspective that defines what an “employment business” is. Each arrangement between an umbrella company and HMRC is defined locally and HMRC treats that as they would any other business. So the term “umbrella company” can encompass many forms of employee management services (another term used).

Employee management services have ranged from:

  • PAYE umbrella - companies deducting tax and NI at source and allowing some business expenses
  • composite schemes (providing shares in a company structure to allow dividends) - no longer viable,
  • offshore schemes - tgread with caution,
  • employee benefit trusts (EBT) based schemes - no longer viable after a big crackdown by HMRC
  • other elaborate tax avoidance schemes

Composite schemes are no longer a viable option due to the Managed Service Company Legislation introduced in the 2007 budget. Other non vanilla schemes have been subject to attack by HMRC in previous Budgets, making the PAYE Umbrella the only viable Umbrella option for contractors.

Most have developed an in-depth service covering such areas as employment contracts, extendable HR functions, comprehensive insurances and employment rights.

How does HMRC view umbrella companies?

Because of the perceived widepsread use of aggressive tax avoidance schemes promoted under the banner of "umbrella company" they are not popular with HMRC.

The reporting of “tax avoidance” schemes partly addresses some of the more dubious operations. HMRC should see the compliant umbrella firms as a good way of collecting tax rather than a way of avoiding it.

There is legislation that tackles schemes that purport to provide high net pay returns whilst allowing the safer versions to continue collecting good levels of tax/NI for HMRC and at the same time offer freelance workers a legitimate and convenient trading structure.

In 2016 HMRC introduced new rules surrounding expenses that could be claimed by contractors using umbrella companies. Contractors that are subject to supervision, direction and control (SDC) can no longer claim expenses. This has made the umbrella option very unattractive for any contractors who are outside the IR35 legislation.

What is a dispensation agreement?

Every business would normally be required to complete P11D’s for each and every employee in relation to expenses claimed. A dispensation is simply a way of reducing paperwork as the granting of a dispensation relieves the employer (umbrella) from having to complete P11D or P9D’s.

It can further simplify the process for employees as they do not have to include details of the expenses and benefits covered by the dispensation in their tax returns. Nor are the expenses and benefits included in either their tax assessments or PAYE codes.

These factors make a dispensation attractive for umbrella companies; it simplifies the administration (passing a cost saving back to the individual) and is an attractive sales pitch. What a dispensation does not allow is for the individual nor the umbrella company to allow expense allowances when no real expenditure has taken place.

Furthermore it does not “guarantee” that the individual should not have receipts for business expenditure. Some umbrella companies historically stretched the dispensation point to the absolute limit - hence the need for HMRC to introduce further legislation to curb expenses claimed by contractors using umbrella companies.

Are umbrellas still worth using?

Umbrella companies are designed to remove nearly all the administration and company management associated with a limited company, which is why they are such a popular choice for contractors.

The main advantages for using an umbrella company are:

  • It means you avoid the hassle of running a limited company
  • There is no need to be involved with uploading data to an online solution, completing VAT returns, submitting RTI returns, company accounts, taxation, director’s responsibilities and so on
  • For short-term contractors, a main advantage is not having the time consuming process of forming a company and then arranging for it to be dissolved

Naturally, there is a charge for such relative ease and convenience and, for those whose contracts are outside IR35, the real cost of using an umbrella company is in a considerably lower net income than they could otherwise earn by contracting through a limited company.

Updated: Monday, January 15, 2018

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