Does IR35 Apply to Umbrella Companies?

IR35 is one of those vague tax rules that no one really understands the implications of yet (mainly because it’s open to interpretation). But while the UK comes to grips with how IR35 is being interpreted by the tax authorities, we’ve written a post to help you understand it as best you can.

What is the purpose of IR35?

The easiest way to describe the purpose of IR35 is that it exists to determine whether someone is a genuine contractor or an employee. This difference is very important when it comes to calculating the amount of income tax and national insurance that they should pay.

Also known as the ‘intermediaries’ legislation’, IR35 is a set of tax laws designed to help make that distinction. The government implemented it in early 2000 as part of its plan to stop anyone avoiding paying income tax and national insurance for their work. Specifically, this was happening when contractors left work on a Friday, set up a limited company (which provides tax benefits for its owners) and returned to work as a contractor on the Monday.

This was a lose lose situation for government tax revenues. However since its inception IR35 has evolved into a wider program not just of tax reclamation (which many argue is justified) into one of actively generating further tax revenues by targeting legitimately self-employed workers who perform a role similar to those of an employee.

Employees vs contractors

If you work as an employee for a company, you are subject to certain levels of national insurance and income tax. The argument is that as an employee you’re taking a low economic risk and therefore you don’t need ot be encourage through tax breaks to invest your money in the economy.

As a result, your employer calculates and takes your tax directly from your salary as pretty straight forward rates.

On the other hand, contractors with limited companies are encouraged to invest back into the economy by paying lower taxes on their company profits. Lower taxes is their reward for being entrepreneurial and creating wealth in the economy.

Despite doing roles that are often similar to an employee, contractors as the owner of a limited company can split their income between a salary and dividends, which are taxed at a lower rate.

The argument is that as contractors have zero job security, zero employment benefits and run their own business, they should have access to the tax beneficial Limited Company structures that business owners use. However in gaining access to these structure, HMRC would argue that contractors are able to pay less tax.

The argument then between employee and contractor is one that HMRC sees as a potential winner for tax returns, making IR35 (and classing all contractors as employees for tax purposes) as a weapon in their arsenal to pump us tax revenues.

How does IR35 work?

There isn’t a definitive way of determining whether you should be classed as an employee, a limited company or a sole trader in the eyes of IR35. This is because HMRC are not quite sure themselves (as recent court cases have shown even HMRC will argue against their own advice if it is to their financial advantage).

However history shows there are a few key factors that HMRC considers when determining a person’s IR35 status. These can include how much control you have over where, when and how you work. Or if you can send a substitute to complete your work for you. Another factor is the expectation of the work and what you are obliged to do.

Companies expect employees to work when asked and employees expect the company to give them constant work. Self-employed people expect payment for their services but don’t expect to receive any further work after they complete a specific amount. Another important way of showing self-employment is through your ability to choose work. This could be turning down work or picking up any more work outside of the initial contract.

As you can tell these are all factors that are open to interpretation. It’s highly unlikely that a Doctor would send someone else to perform their operation or wear anything they like in the operating theatre.

There are many other identifiers HMRC will consider, including who provides the equipment for the job, whether you have several clients and even how often a client provides you with work. According to one clause, HMRC argues that “where work is regularly offered and accepted over a period of time a continuous contract of employment may be created.” In essence, if you have a good client, HMRC might deem you their employee simply because they don’t want to work with anyone else!

If you want to make sure that you are fully IR35 compliant, it’s important to make sure that your contracts show that you are a ‘business in your own account”, factoring in the realistic behaviors of your industry.

This could be demonstrated by things like having your own office, a company website and taking holidays whenever you want. In contrast you shouldn’t do things that make you look like an employee e.g. allow yourself to be managed by an employed manager in a team or attend work at set hours.

How does IR35 affect umbrella companies?

With IR35 so open to interpretation (and HMRC changing its definition by the week) it’s easier to side step the farcical situation entirely by using an Umbrella Company.

When you complete your work through an umbrella company, you are treated as an employee and are paid through the PAYE system. This means that IR35 won’t have an effect. IR35 is designed to catch out ‘disguised employees,’ and if you operate as an employee of an umbrella company this ceases to be a concern.

Umbrella companies are a very useful way for people to carry out contract work without the hassle that can come with starting a limited company or being a sole trader. Umbrella companies manage all the paperwork and administration of taxes. They will also deduct them from your pay, so you don’t have the worry. In return you pay a percentage of your earnings to the umbrella company for using their services.

In the past, some umbrella companies have tried to market themselves as being ‘IR35 compliant’ to try and persuade contractors to use their services. This phrasing can be misleading simply because a more accurate phrase would be that umbrellas are “IR35 irrelevent”.

Another way to describe this situation is being ‘outside IR35’ which may also be used in marketing for umbrella companies. As umbrella companies meet this criteria by nature, selling the idea of IR35 compliance can make it sound like an extra perk rather than the standard.

Is an umbrella company right for you?

All in all, umbrella companies make it easier for contractors to work for themselves. As well as eliminating the hassle of IR35, they provide invaluable statutory benefits like holiday pay, sick pay and paid maternity or paternity leave. However, they also vary in the fees they charge and the other perks on offer.

At Umbrella Supermarket, we make it easy to compare umbrella companies and find the best for you. Use our umbrella comparison site to get quotes from leading providers in under two minutes.