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Thinking about Contracting

First Timer's Guide

Introduction

If you are new to the world of temporary work or contracting, you may be struggling to understand the jargon and the complex rules and regulations you will need to follow in order to work as a contractor. Here at OrangeGenie we specialise in understanding the legislation and eliminating the jargon in order to provide you with clear, easy-to-understand, and impartial advice. It will make your life easier and less stressful if you start with the right service.

Contracting used to be simple you could sign a contract and start work on a self-employed basis or work through your own limited company. Unfortunately over the last 10/15 years both the UK and EU Governments have imposed layer upon layer of new legislation that have changed the landscape and made your life more difficult and more complex.

Key Legislation

Four key pieces of legislation have shaped the market and limited the style of working. They are all loosely related to maximising HMRC's tax take, refered to by Government as 'paying your fair share of taxation'.

The Intermediaries Legislation 2000 (IR35)

This legislation placed responsibility for determining employment status with the contractor. Employment status effectively determines your tax position and impacts directly on your choice of trading options. The legislation seeks to differentiate between profressional contractors genuinely in business in their own right who provide their services with minimum levels of supervision and control and, individuals who, although they may not work under a contract of employment, can be regarded as 'disguised or deemed employees'. A 'deemed employee' even if working through your own limited company is unable to benefit from the tax advantages of taking part of your salary as a dividend. The IR35 legislation has resulted in increased tax, NIC liability and a significant increase in both risk and administration for those contractors using a Personal Service Company. This made the use of Umbrella Companies significantly more attractive.

The Conduct of Employment Agencies Act 2003 (EAA) and S44-47 ITEPA 2003

The net effect of these pieces of legislation were to make the employment of self-employed contractors far less attractive. If the contractor avoided paying the correct amount of tax, this legislation placed the onus of proof and responsibility for payment on the end client or the recruitment agency. As a result we saw a move away from the use of self-employed contractors and an increase in contractors working through Agency PAYE schemes.

The Managed Service Company Legislation 2007 (MSC)

This legislation was introduced to make the use of composite companies, where contractors were encouraged to trade through Limited Companies as one of several director/shareholders in order to attract the tax benefits available to genuine personal service companies. The companies were managed by a 3rd party or 'scheme provider' who ran the back-office and statutory administration. These schemes were clearly contrived, the contractors avoided taxation and responsibilities of running their own business. Although not outlawed the legislation removed all the tax advantages of this type of arrangement. A number of scheme providers have continued to operate and we understand these are being targeted by HMRC investigators.

Working as a Contractor

Essentially the legislation has created three main methods of working as a contractor:

Own Limited Company
Employment with a PAYE Umbrella Company
Agency PAYE

Self-employment remains an option but is rare amongst more highly paid contractors and unpopular with most agencies.

You will see other offers including 'offshore umbrella' and 'employee benefit trusts'. Please be warned these solutions may appear to save you tax, in reality they are contrived and extremely high risk. It is only a matter of time before you get caught - 'if it looks too good to be true it probably is'

Limited Companies
Umbrella Companies
PAYE through Agencies

If your contract is outside IR35 (you are not a 'deemed employee')the tax advantages of working this way can far outweighed any other method. If your contract is caught by IR35 the main tax advantage (paying yourself a dividend rather than salary) is removed. As a general rule, if you fall outside the IR35 rules then you will be most likely better off using a Limited Company, whereas an Umbrella Company would probably be more beneficial otherwise.

With a limited company structure, the contractor will be the director/shareholder of the company and will be in full control of all company transactions.

As director of the company, you will be fully responsible for compliance with all company and other statutory issues, including company law requirements to file accounts and returns to Companies House, calculation and payment of corporation tax liabilities, payroll calculations and returns and various other statutory and other Government requirements.

You would typically raise all company invoices, collect payments, run an accounting system to record transactions and appoint an accountant to deal with accounts, taxation and payroll matters on your behalf.

An Umbrella Company provides a ready made invoicing vehicle for contractors whilst also removing the administrative duties normally associated with contracting in the form of a Personal Service Company. The Umbrella Company normally issues invoices on the contractor's behalf, collects payments from clients/agencies, calculates tax & NIC and pays the contractor their net pay direct to their personal bank account.

Traditionally, Umbrella Companies were more expensive than running a Limited Company, mainly because their charges included all the administration overheads, and they tended not to offer the same tax advantages. With the introduction of IR35 the tax advantages of Umbrella Companies make this route the most attractive option particularly as greater business expenses are allowed. This is because the Inland Revenue grant reputable Umbrella Companies 'Dispensation ' - allowing the Umbrella Company's clients to off-set certain costs against their tax bill.

IR35 is a potential problem for Personal Service Companies as it is designed to tax excess (from the IR perspective) profits. The vast majority of safe and reliable Umbrella Company employees are not hindered by this as they are employed by the company and taxed at source. The key point is that all the hassle and worries make the safe Umbrella option a very viable route.

Some agencies allow you to become "PAYE" through their own payroll service. This is the least tax beneficial option available to a contractor as you pay full tax & NIC on all your earnings. In addition this option does not allow you to claim valid business expenses which would help to reduce your tax and NI liabilities.

Summary - your choices

One of the issues that has driven HMRC's focus towards the contracting marketplace, is a belief that choosing your preferred operating structure is primarily driven by tax considerations. This misconception and the poor drafting of legislation has made operating as a contractor far more complex that it should be. Uncertainty in the legislation allows exotic and fanciful schemes to exist.

With the introduction of MSC legislation, it was clear that HMRC will make an assessment of whether they believe the chosen operating structure is one that would have been 'professionally advised' or just chosen as a way of reducing tax liabilities.

It is perfectly acceptable business practice to reduce your tax burden, and in fact, a number of professional bodies state this as an aim to their members. The difference in the contracting market is the raft of legislation that HMRC can use if they disagree with the advice.

So lets look at some of the drivers:

Consider running your own Limited Company if the following apply:

Long term aspiration to be a contractor for more than 12/18 months
Experience, role and a charge out rate above £20ph
IR35 status (outside)
Willing to accept the responsibilities of a Director (Companies Act 2006)
Capable of managing your finances
Ensuring your business is appropriately insured

Consider employment with an Umbrella Company if the following apply:

Short term career aspiration, assignment length under 12 months.
Don't like the uncertainty of contracting but hoping to secure successive assignments
IR35 status (deemed employee)
Role and charge out rate between £9ph and £20ph
Not willing to take responsibility of running your own business

Consider Agency PAYE if the following apply:

Single assignment
Charge out rate under £9ph
Junior role