First Timers Guide

Introduction

Historically, a majority of contractors worked through their own limited company as the tax advantages of working this way far outweighed any other method of working. Intermediaries such as service companies could be set up to provide the services of one individual to a client company enabling the client to make payments to the company without deducting PAYE or NIC. The contractor would be able to take payments from the company in the form of dividends instead of a salary saving National Insurance Contributions in the process.

In the 1999 Budget the Chancellor announced his intention to tackle tax and NIC avoidance through the use of personal service companies. The new rules were proposed to remove the opportunity for the avoidance of tax & NIC by the use of any intermediaries' i.e. Personal Service Companies.

What is IR35?

The Inland Revenue Code of Practice IR35 has transformed the taxation of Contractors. Since these regulations were introduced they have placed the responsibility for determining employment status squarely on the shoulders of the Contractor. Essentially, the government identified Contractors as 'tax avoiders', due to the tax saving benefits they enjoyed from working through a Personal Service Company, while performing roles similar in nature to those of permanent employees. Although the Revenue claimed that the initial targets were 'Friday to Monday' workers (permanent employees who return the next week as contractors), it has since become clear that IR35 was created to apply to all freelance contractors.

The IR35 legislation was implemented in April 2000 and has resulted in an increased tax, NIC liability and administration for those contractors using a Personal Service Company and made the use of Umbrella Companies significantly more attractive than in the past.

Who is affected by IR35?

Essentially, IR35 affects all contractors who do not meet the Inland Revenue's definition of 'self employment'. As a general rule if you only have one current contract (i.e. you do not have multiple contracts at the same time), you travel to the same workplace each day, you are paid by the hour or day, you work under the jurisdiction of the client and you have no right of substitution (i.e. if you cannot go into work that day you cannot send someone in your place) then you will NOT meet the Inland Revenue's self employment definition and you WILL fall under the IR35 legislation.

Choosing How to Operate
The options available to you are:

Your own Limited Company
Umbrella Company

• PAYE through the Agency

1. Your own Limited Company

Following the introduction of the new MSC legislation we are reluctant to recommend this type of structure. The uncertainty over the exemptions available for ‘Accounting Services' means that many service providers who currently claim to be exempt from the legislation will be caught. Those limited companies using the services of an MSC provider will be caught by the legislation and face potentially huge bills for back dated tax, penalties and interest. We are not recommending the use of own limited companies until the courts give more clarity.

However the tax advantages of working this way, if your contract is outside IR35, 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, he/she 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.
The director would typically raise all company invoices, run a simple spreadsheet or accounting system to record transactions and appoint an accountant to deal with accounts, taxation and payroll matters on his/her behalf.

2. Umbrella Company

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.

3. PAYE through the Agency

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.

Maximising Your Earnings

As a contractor, you will be required to fill in timesheets detailing the work you have done for the Client, and the number of hours or days you have worked in a given time period. Your manager will typically authorise (sign) your timesheet.
Currently timesheets are mainly paper based and most agencies and clients require an invoice to accompany each timesheet, detailing the total amount owed for services performed, plus VAT (if you are VAT registered).

Some of the larger agencies also offer a self-billing option where they create an invoice on your behalf when they receive your authorised timesheet. Payment times can vary from agency to agency, although most of the larger ones tend to pay promptly (some within 7 days). A payment cycle of 1 to 2 weeks from invoice creation to receiving the money in the bank is typical. Fingers crossed, you shouldn't experience any payment delays, but if you do - chase up the agency/client.

It is important to keep your timesheets and invoices up to date, ensuring they are sent in at regular intervals. If you run your own limited company then you are your own 'finance director' as a contractor, and in charge of your Company affairs. The responsibility for these matters resides with you. This is a 'downside' of contracting.
OrangeGenie perform all these administrative tasks on your behalf, prepare your year end tax reports, submit and agree them with the Inland Revenue.

You are able to claim tax relief on business expenses that you incur against your earnings and minimise your tax & NIC payments.
The key point is that all the hassle and worries associated with contracting make working through OrangeGenie a safe option as you will be maximising your take home pay and complying with all Inland Revenue regulations.