This article first appeared in Retirement Planner on 28 January 2020.
By working via a limited company, a worker could pay less tax than a traditional employee performing exactly the same role. The IR35 rules apply to contracts which are performed in the manner of an employee rather than a self-employed person working in business on their own account. Although the tax benefit associated with working via a company has gradually been eroded over the years, there is still a significant financial cost if your work is caught by IR35.
Although there have been calls for and promises of a review of the IR35 rules, off-payroll working rules changed on 6 April 2021. From this date, all public authorities and medium and large sized businesses in the private sector will be responsible for deciding the employment status of workers rather than the worker having that responsibility. The private sector includes third sector organisations, such as some charities.
The rules apply to private sector companies that meet 2 or more of the following conditions:
In some cases, a contractor may only be offered the role if they become a traditional PAYE employee, or they may take up the contract and operate via a PAYE umbrella company.
If they take the role as a limited company contractor, their fee-payer/client will be responsible for making the appropriate deductions from their turnover. This includes income tax and employee’s National Insurance contributions. The fee payer must also make deductions for employers’ National Insurance contributions and the Apprenticeship Levy. But the contractor will still be responsible for any additional tax due as it’s possible for one contract to be treated in one way with others treated differently depending on the circumstances.
However one of the most unfair aspects of IR35 is that if a contract is deemed to be caught by IR35 and the contractor continues to operate through a personal service company, then they will be taxed as an ’employee’, but have none of the statutory employment rights associated with traditional workers. There will be no entitlement to benefits such as holiday pay, statutory sick pay, maternity or paternity pay, pensions or redundancy.
But things are different if operating via a PAYE umbrella company. A contractor is an employee of its chosen umbrella employer and with that comes a responsibility for the umbrella firm to provide all normal HR functions of any employment relationship. Umbrella employers provide contractors with full employment rights, all statutory benefits including holiday pay, maternity pay, paternity pay, sickness pay, pensions, redundancy pay and adoption pay. The contractor has the best of both worlds. The stability and benefits of being employed whilst also having the freedom and flexibility to undertake contract work for numerous end-clients.
Even when undertaking placements for different recruitment agencies, there is continuity of employment. This history can be particularly important for anyone looking to access personal finance such as mortgages or loans. For anyone working on very short-term contracts or working for multiple clients simultaneously, the umbrella consolidates earnings from the various assignments into one pay packet. This means that all tax and National Insurance contributions are taken care of together for the contractor, rather than having to consider earnings from each assignment separately.
It’s inevitable that some people will ditch their personal service company and become a true employee. Some will continue as they are and take each contract on its own merits. For some within that cohort there will be no real impact and the world will continue to turn as it did before as they were and always will be outside of IR35. Others in that cohort will take account of the end client decision on whether they are within or outside of IR35 for that particular contract and negotiate their rate appropriately taking into account the tax consequences. But there will be a further group that will either choose for themselves or be forced by their end client to operate through a PAYE umbrella company.
This is what creates a tremendous opportunity for advisers. Before taking a decision one way or the other all current contractors should seek professional advice. This will initially be about their tax position but it also creates an opportunity to talk to clients about their situation from a protection and long term savings perspective.
From a protection point of view it is an opportunity to review existing cover to see whether it is still appropriate or needs to be changed. For example, for those that choose to maintain their personal service company, it will be important to maintain any protection that already replaces the normal employee benefits, e.g. Income Protection, death in service via a Relevant Life Policy or private medical insurance even though they may be taxed differently.
For those choosing a different operating model, advisers should consider the portability of existing arrangements. For example if they have a relevant life policy how easy is it to continue as a personal policy? If they currently have company sponsored income protection, can this be continued on a personal basis?
If a client doesn’t already have such cover, now may be the time to remind them how vulnerable they are by not having cover. And if they decide to put cover in place now, make sure it’s arranged in a way that it is flexible enough to cope with future changes in their employment status.
There will also be many advisers about to start end of year tax planning with their customers. This often involves decisions on how much to put into a pension. But maybe this year there should be a greater emphasis on their protection needs than would previously have been the case.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.