In the mad rush to get out of Managed Service Companies in April 2007, many contract workers that felt that they would normally fall foul of IR35, have turned to Umbrella companies rather than going PAYE. The Umbrella company promises to save the contractor money by not paying so much tax as they say they have dispensations from the Tax office to pay the contractor tax free expenses. It is a bit of a minefield that is shrouded in myths and preconceptions.
To help you separate the myths from the facts, contractorumbrella.com have compiled a list of common misconceptions and the truth that lies behind them:
Myth: A special dispensation with the Inland Revenue means one company can allow freelancers to claim more expenses than another.
Fact: A dispensation relieves a company from reporting expense payments and benefits on a P11D form. The dispensation applies to the company’s accounting practices rather than what you can claim as an individual. As a contractor, you can only claim those expenses that are approved by the Inland Revenue and they must be supported by receipts. H M Revenue and Customs does not “approve” any particular composite or umbrella companies – Extract from an email received from the Inland Revenue.
Myth: A subsistence payment is an expense I can claim, without receipts, for being out of the house more than a certain amount of hours per day.
Fact: A subsistence payment is, by definition, one that does not have to be supported by receipts. The only subsistence payment permitted by the Inland Revenue is £5 per night (£10 if abroad) for each night spent away from home during the course of the contract. All other expense claims must be supported by receipts according to Inland Revenue legislation. “I can confirm that contractors cannot automatically claim £21 per day (or any other amount) for each day they are at work. It is also worth saying the Inland Revenue would not give general approval of a company’s expenses policy. A dispensation would never cover large amounts of unsupported expenditure” – Extract taken a letter received from the Inland Revenue regarding daily allowances.
Myth: I can claim a meal allowance as an expense
Fact: You can claim actual meal costs whilst you are working at a remote site, away from your normal place of work, or when staying away home overnight but daily claims for meals are not permitted. It is the Inland Revenue’s belief that you need to eat regardless of whether you are at work or not so the meal costs are not wholly attributable the contract. The cost of food, drink and accommodation is not in general an expense incurred wholly and exclusively for business purposes, since everyone must eat in order to live…
– Extract taken from the Inland Revenue website http://www.hmrc.gov.uk
Myth: Some Umbrella Companies charge a high fee but they can guarantee that I will pay less tax.
Fact: All Umbrella Companies are controlled by the Inland Revenue. Your tax paid is dependant on your personal tax code, National Insurance contributions are a fixed percentage and you can only claim those expenses that are permitted by the Inland Revenue. Remember, a dispensation means that the Umbrella Company does not need to see your receipts; it does not mean that you don’t have to have them! The only factor that should affect your take home pay is the Umbrella Companies fees and whether they retain any money for holiday or sick pay.
Myth: An online calculator only needs my hourly or daily rate to work out my earnings.
Fact: Your net earnings will be affected by your tax code and the expenses that you can legally claim. An online calculator should operate using a standard tax code and a calculator that does not ask for your expenses will assume a figure. This means that the calculation will never be accurate as everyone’s expenses are different.
Myth: An umbrella company or composite company can pay me a minimum salary and dividends, which will earn me more money.
Fact: Being paid salary and dividends would be more financially beneficial to you, however you can only be paid in this way if your contract is IR35 friendly (outside IR35). If your contract fails IR35 (inside IR35) you can only be paid through PAYE whether you are using an umbrella company or running your own limited company. …then the service company will have to deduct and account for tax under PAYE and Class 1 National Insurance contributions in respect of that worker on (broadly) all of the money the service company receives from the client in respect of work done for the client by that worker.
– Extract taken from Composite Service Companies and the ‘Service Company’ legislation (‘IR35’) on the Inland Revenue website http://www.hmrc.gov.uk
Myth: I can pay part of my salary to my partner for admin etc to minimise my tax contributions.
Fact: Under HMRC Section 660A this is not possible.
Myth: I can just switch Umbrella Company when I breach the 24-month rule and continue to claim expenses.
Fact: Moving Umbrella Company will not change the situation as the rule applies to your actual place of work rather than the company you use. A workplace is deemed as a temporary site providing your attendance lasts no longer than 24 months. After 24 months a workplace is viewed more as a permanent site, and if you spend 40% or more of your time at the same site, you are no longer able to claim travel between home and that place or accommodation expenses.
The following link is an example of the 24-month rule, taken from the Inland Revenue website: http://www.hmrc.gov.uk
Myth: I am protected from investigation from the Inland Revenue by my umbrella company.
Fact: If you claim expenses fraudulently and the Inland Revenue become aware of it you will be investigated and you will be liable for any underpayments of tax and associated penalties. It is worth noting that the Inland Revenue do investigate and no company can offer you protection against an investigation. Direct from Inland Revenue website: Where we find that the incorrect classification has been applied in respect of a particular engagement, we have a duty to ensure things are put right for the past and, where appropriate, for the future. Interest and penalties may be charged on any additional tax/NICs due as a result of any review or enquiry. http://www.hmrc.gov.uk
Myth: An offshore umbrella company can reduce my tax and NI liabilities because UK tax regulations do not apply to them.
Fact: Extract taken directly from HMRC website www.hmrc.gov.uk If you would have been liable to UK tax and NICs had you been employed directly by the client, you must pay UK tax and NICs under these rules, whether or not your service company is located in the UK. If an offshore company fails to deduct and account for PAYE tax and NICs under the legislation, liability to pay tax and NICs can be transferred to you. HMRC has powers to obtain details of payments to offshore companies from the records of clients and agencies. Our opinion of Umbrella Company’s at RoS International is that although at first glance Umbrella companies may be able to save a lot of money, but it is only a temporary solution, especially if your contract runs for more than 24 months with the same client, there are a lot of potential pitfalls that a temporary worker may fall into, and ultimately get themselves into deep bother with HRMC. Whilst we do not turn away contractors that are using Umbrella Co.s we do not recommend it as a way of saving a significant amount of money, once the fees have been paid to the Umbrella Co. a much safer way is to be PAYE through the agency.