Empowering the Freelance Economy

Inside IR35 – Are contractors paying over the odds to indirectly cover ENI and umbrella company margins? If so, are there alternatives?

Limited company contractors may need to look to smaller companies and startups for future work so that they can determine their own destiny, ensure their correct IR35 status, and avoid weekly umbrella company fees they cannot afford. The Freelance Informer reports.

As it stands, there is actually very little difference in personal tax between an employee and a contractor, according to Qdos, the contractor insurance broker and IR35 tax specialist. However, the firm says that the big chunk of tax HMRC is after is Employers National Insurance, which is the 13.8% companies pay on top of their employees’ salaries.

“Unfortunately, for contractors operating inside IR35 this cost is often indirectly passed down to them,” says Qdos CEO Seb Maley. “Therefore, in the majority of cases a contractor operating outside IR35 will be in a far better position financially.”

Many people have gone the limited company route because the companies they work for prefer it due to limited liability concerns (hence why limited companies may be asked to take out special insurance before you can work on their behalf). However, there is arguably a more important reason and that is a limited company is a separate legal entity to you and your family’s assets, including your home, so your personal finances and assets should be protected in the event of a claim against your company. No one wants to lose the house over their head.

You can put certain business expenses through your company and take advantage of tax relief on lifestyle benefits, including pensions and life insurance.

Since you are running your own business you can undertake activities outside of your normal contracts as well. However, it is vital that you ensure any non-agency/non-umbrella company freelancer contracts do not catch you out for being inside IR35. If these are not caught by IR35, this part will be outside the deemed payments. But this may mean in addition to paying umbrella fees for certain contracts, you will also have to fork out for an accountant unless you are confident you can handle your company registration through an agent and keep on top of bookkeeping.

Is IR35 becoming discriminatory by nature?

Come April 2021, large firms that will have the onus of determining a contractor’s status inside or outside IR35, could be discouraged from engaging limited company contractors, says Maley.

“They will likely be aware that the responsibility for determining contractors’ status will move to them from 6th April 2021, which may seem like a daunting burden and potential risk,” he says.

Contractors should do their homework if their clients have not. For example, if a contractor can prove a lacking in mutuality of obligation (MOO) and control, whereby they are not guaranteed work on a daily basis and are only paid on supply of work, they are likely to be deemed a legitimate business and self-employed, rather than as a ‘disguised’ employee.

If on inspection a contractor feels they may be caught in a questionable employee status under IR35 for previous contracts, then there is IR 35 insurance to consider. Liabilities could be significant, with interest and potential penalties added to them.

Insurance should meet the needs of the self-employed inside and outside IR35, which typically has two elements. According to Qdos, firstly a policy will cover the defence costs in the event of an HMRC investigation, given that IR35 enquiries can typically take upwards of 18 months to conclude. Some policies may also go one step further and cover the potential liabilities if a contractor is ultimately found to be inside, or ‘caught’ by IR35.

Key questions to ask yourself

The key question any freelancer should ask themselves is ‘how much control does the client have over how I carry out my work?’ The second question could be ‘can I ensure or negotiate my freelancer contract to ensure I am outside IR 35’? Sometimes, hiring companies will use outdated or blanket contracts that use terminology that can be misconstrued by HMRC as having considerable control over the freelancer, when in fact that is not the case at all.

And if a hiring company will not budge on the contract wording (which you should bring to their attention) you may have to ask yourself, ‘if they are comfortable working with an umbrella company and their margins for the sake of IR35 jitters, how do I weigh up the umbrella company related costs and how it will impact my monthly outgoings?’

For example, the take-home pay loss in additional National Insurance payments as part of the umbrella company’s day rate prescribed to you and then invoiced to the client, which includes Employers National Insurance, sometimes also including Apprenticeship Scheme costs, the umbrella company’s margin on your day rate, in addition to any umbrella company costs to you for PAYE processing’? Is the umbrella company acting like an employer in the true sense of the word, i.e., offering me any other benefits- holiday and sick pay, a pension scheme where I can put in pre-taxed income to build up my pension pot, and any salary protection should the client drop my contract suddenly due to COVID-related cost cuts? Or are they taking a percentage of my invoices, which can go up and down, without any additional benefit to me when their income goes up due to my hard work?

Smaller company, smaller headache?

According to the IPSE, small clients are exempt from the new rules. “If your client is ‘small’ that means you remain liable for IR35, just as you always have done,” according to a press statement.

For the purposes of this legislation, IPSE says a client is small if they meet two of the following three criteria:

  • No more than 50 employees
  • No more than £10.2m turnover
  • No more than £5.1m on the balance sheet

Once again HMRC will continue to enforce the ‘old rules’ where the client is small, says the IPSE, so you will still need to consider the IR35 of your engagements with small clients. If the HMRC believes IR35 applies, they hold you liable for tax. 

However, some contractors and freelancers may want to start looking for opportunities with smaller companies and startups, which enable freelancers to continue working as self-employed, put the onus on IR35 status determination on the freelancer, have the flexibility to work with multiple clients at the same time, and not be bound to expensive umbrella company fees or margins (which at an average of £25/week starts to add up).

However, being a limited company usually means hiring an accountant for tax accuracy and efficiency, which will cost in the region of up to £1,500 per year, which often includes registered company mail forwarding services. On the other side of the coin, if you work from home, it may prove difficult if not impossible to claim office expenses, such as office equipment, heating costs, and other costs of running a business, if you are invoicing through an umbrella company.

Time to talk

These are precarious times, and while we see certain self-employed individuals getting help from the government, limited company directors, new companies, and others have been left out without support. If you have a good relationship with your client it may be worth asking their intentions now about hiring limited company freelancers, are they creating outside IR35 compliant contracts? It is worth discussing their stance on you going through an umbrella company and the related costs to you both, and even the potential option of working for them as an employee on a part-time basis, i.e. remotely, if that meets your personal circumstances and theirs. It is possible to have side gigs and be an employee at the same time as long as there is no conflict of interest.

Whatever path you choose, start weighing up your options before IR35 really kicks in come April 2021. This is your livelihood we are talking about.

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