IR35-compliant umbrella companies – information for end clients

We’ve fielded many questions from clients recently who want to know how the recent change to off-payroll working rules (IR35) affects if them they use an umbrella company to find contractors.

In this article, written for employers who attract the best contractors, we explain:

The relationship between a contractor and their umbrella company
What contractors pay umbrella companies
The reasons companies use umbrella companies and what it costs your contractors
Why employers choose umbrella companies against contractors’ wishes
Three common umbrella company myths
How to provide a friendly, welcoming tax-efficient environment for your contractors.

For more information on IR35 compliance for employers, please call +44 (0) 203 051 9792, email [email protected] or fill out the form below.

The relationship between a contractor and their umbrella company

Contractors work through their own limited company for a reason. The biggest reason is that working this way, their client doesn’t deduct income tax or National Insurance contributions from them at source. Working this way is by far the most tax efficient for your contractors.

Second, contractors are independent professionals who want to deal with their clients directly. Many of them don’t like having an intermediary involved when they can do just fine without them. working through an umbrella company because of the loss of control it entails.

Therefore, many contractors providing services through their own limited companies will not entertain the idea of working with you if you insist on using an umbrella company.

How much do umbrella company contractors lose out by?

Most umbrella companies charge from £30-£40 a week for processing a time sheet. They deduct this from the money they bill you, the end client. Your contractor would have got this money if you’d be working with them direct.

That’s not their only loss they face as they pay other fees that can cost them up to 9% or more of their take-home pay. Umbrella companies often also change what they charge contractors for based on the number of hours they bill for. The fewer hours, the higher the fees.

On top of all this, they’re paying tax at a much higher rate on their gross pay. They’re paying income tax, National Insurance plus the Apprenticeship Levy and this costs a lot more than the corporation tax and dividends they’d pay outside IR35.

It doesn’t end there. Because you as the end client get the benefit of your contractor’s service, the umbrella company does not have to pay employer National Insurance Contributions (at 15.05% of gross salary). That’s ALSO the contractor’s responsibility.

So what you advertise your rate at, your contractor actually gets paid a lot less through an umbrella company.

On the other hand, they do have employment rights. This means they get statutory benefits like holiday pay, sick pay, maternity pay, paternity pay, pension contributions and more under their employment contract.

Ask most contractors though and they’d much prefer to work outside IR35 directly with you or through recruitment agencies.

Why do employers use umbrella companies despite their contractors’ wishes?

After contractor IR35 self-determination ended in the public sector (in April 2017) and for medium and large businesses in the private sector (in April 2021), many employers took understandable fright.

If they declared their contractors as working outside IR35 but HMRC later found them to be inside IR35, they would be liable to significant future tax bills and penalties. They would pay income tax, National Insurance and the Apprenticeship Levy for all contractors whoseIR35 status determination statements were wrong via a deemed payment at the end of the year under the new tax rules.

In the 20 years since IR35 was introduced, contractors had developed a deep understanding of employment law meaning that they could, in association with their clients, create IR35-compliant written contracts and working conditions. HMRC spent two decades chasing individual taxpayers at great expense and often ended up on the losing side. If a contractor got it wrong, they alone would be responsible for paying the unpaid taxes they had accumulated.

By switching responsibility for IR35 determination to clients who were less informed than their contractors (no offence) as well as the responsibility to pay all fines and penalties, HMRC put a massive ticking time bomb in the laps of employers.

The size of fines they’d face may threaten the existence of their companies if they misclassified enough of their contingent workers. And because there are far fewer clients than they are contractors, they’d be more likely to be investigated.

Typical umbrella company myths

Mythbuster – HMRC-approved umbrella companies

HMRC-approved umbrella companies are a myth. They don’t exist. In their own words, “HMRC does not approve or endorse umbrella companies or tax avoidance schemes”.

If an umbrella company is promoting itself as something it is not, as many umbrella companies do, we respectfully recommend that you ask yourself why.

Mythbuster – membership of the Freelancer & Contractor Services Association is the sign of a reliable umbrella company

At the time this article was written, there are over seventy umbrella companies that belong to the Freelancer & Contractor Services Association (FCSA). The FCSA campaigns to “raise standards and promote supply chain compliance in the temporary labour market”.

Recently, the head of the FSCA has threatened to report non-compliant umbrella companies for, among other activities, if they promote a disguised remuneration scheme or tax avoidance scheme to contractors. Such schemes are almost always illegal.

While that’s encouraging, using an umbrella company to hire, manage and pay limited company contractors is probably still the last thing they want.

The “best umbrella company” will take as little from a contractor by way of a fee for their services. But that does not make them a good umbrella company to contractors who get hit for fees and taxes they’d not have to pay if they were outside IR35.

Mythbuster – some umbrella companies have special arrangements with HMRC

This is completely untrue. All umbrella companies operate by the same tax rules, no matter what a specific umbrella company claims.

If an umbrella company claims that they charge contractors less, it is almost certain that they are running non-compliant schemes that HMRC will investigate at some future point.

Provide a contractor-friendly environment for your off-payroll staff

Umbrella companies are glorified payroll operators charging outrageous sums of money for very little work. There has been talk of the government clamping down on their existence for years and, in our opinion, it can’t come too soon.

Work direct with your contractors and keep them outside IR35 with CoComply instead.

Don’t force your contractors to use CIS payroll providers, so-called “contractor accountants” or an umbrella firm. Let them keep much more of their money and reduce the cost of your contingent workforce.

The rules on determination may have changed but the definition of IR35 remains the same.

We help clients in the public and private sector provide a friendly, welcoming and tax-efficient environment for their contractors from before work begins right up to the final payment. To find out more, please get in touch.