The UK tax legislation surrounding contractors seems to get
more and more confusing and convoluted every year.
The aim of the HMRC is to remove the tax advantages from
contractors who are selling their services via
partnerships, under umbrella or managed service companies.
The view of those very generous people at the Revenue is
that contractors are, in effect, full time employees and
should be taxed accordingly. Contractors, unsurprisingly,
do not agree.
The legislation that governs this often fraught
relationship is IR35. IR35, in (very) brief, a ruling that
states if you can be considered 'employed' by the company
you are contracting your services to, then you are liable
to pay tax and NI contributions as is you were directly
employed by that company.
Some of the indicators that a contractor falls under the
IR35 legislation are as follows :
1)The contractor has no financial risk from working on the
project in question.
2) The contractor does not use his own materials and/or
equipment on the project.
3) The contractor has fixed hours, as a normal 'employee'
would.
4) The contractor works soley for a single client and does
not have several clients.
Contractors looking to maximize their income would be well
advised to be aware of IR35 before signing any contracts.
Avoiding IR35 can make a huge difference to a contractor's
income.
Even better, they should, at the very least, speak to an
accountant who has experience in dealing with contractors
and freelancers.
In essence, contractors falling outside IR35 have two basic
choices, now that Managed Service Companies have
effectively been outlawed by recent changes in legislation.
The first choice is the Umbrella Company.
An umbrella company acts as your employer for tax purposes
when undertaking a contract with either a client or
employment agency.
Umbrella companies raise invoices on your behalf and pay
you once they have received the funds. Many umbrella
companies pay you the same day they receive the funds, but
some will pay you only once a month.
What you will receive from an umbrella company is a payslip
detailing not only your tax and NI contributions (both
employee and employer contributions), your umbrella
company's fees and any expenses claimed.
Umbrella companies have a special dispensation that means
that they can process some expenses without having to
record them on a P11D. This does not mean that, if
investigated, you don't have to produce receipts for all
expenses. You do.
However, all expenses are processed by your umbrella
company, making things very much simpler for you. Expenses
that can be charged to your employment agency or to your
client will be refunded to you in full, while those
expenses which are not are processed as a tax benefit.
The second option available to UK contractors is setting up
a limited company, where you, the contractor, become a
shareholder and director in the company.
Usually, a limited company is the most tax efficient option
for a contractor.
This is because a wider range of expenses can be claimed
back as a limited company and the legislation governing
things like capital allowances is far more detailed for
limited companies. Accountancy fees, capital expenses such
as machinery, research and development costs - all these
things can be claimed back.
In practice, there isn't really that much paperwork
involved, particularly if you choose to hire an accountant
or bookkeeper to take care of such things as your VAT
returns, monthly accounts and payroll.
The limited company offers a greater scope for reducing tax
liability of contractors than does an umbrella company. One
of the reasons is that, as a shareholder and directory of
your company, you can choose to pay yourself a small wage
but take the bulk of your income as dividends, thereby
attracting smaller national insurance and tax liability.
Taking advice from accountants experienced in dealing with
contractors should be your first step in ensuring you
minimise your tax bill and maximise your earnings. At the
very least, you will get to understand the issues and,
perhaps more importantly, how much paperwork is involved in
each of the options available to you.
----------------------------------------------------
Jim Haines works freelance for Just Accountants, a UK
website where contractors can find accountants specialising
in their needs. Visit
http://www.justaccountants.co.uk/ir35.html for details.
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