IR35 Delayed: Umbrella vs Limited Companies

 In Contractors & Freelancers

The Government has delayed IR35 for a year due to COVID-19 but many contractors have already switched to permanent employment or working via an umbrella company.

If you have recently left fulltime work, you will in most cases be presented with the option of using your own Limited company for contracting and determining your own IR35 status, albeit until the changes come through in 2021. We are expecting businesses to be better prepared next year given the time they will have to develop the understanding and processes to better assess contractors’ IR35 status.

Understanding the differences of working via an Umbrella company vs a Limited company is not always clear and we have provided a brief summary below.

Limited versus umbrella

Working as a limited company is currently the preferred approach for most freelancers. It allows you to be the director of your own limited company, enjoying tax advantages and retaining complete autonomy. 

Although this does give you added reporting responsibilities to HMRC and Companies House, plus a whole lot of additional paperwork, the tax benefits and added independence are well worth it (especially if you have a fantastic accounts team on your side such as 3WiseBears of course). 

An umbrella company, on the other hand, doesn’t sound so attractive. First, you’ll have to pay a fee. Most reputable companies will charge £20 or £30 a week which could eat into your income. 

Secondly, you’ll effectively be working as an employee. You’ll receive a monthly salary which is subject to National Insurance and everything which comes with being a regular nine to fiver. 

You’re also working through a third party rather than directly with the end client. You’re therefore dependent on them collecting the money from the end client and paying you which can delay things. 

Worst of all, you won’t be able to optimise your tax through dividends as you can through a limited company. 

The impact of reform

The IR35 changes will shifts responsibility from the contractor to the end client with expensive fines involved for companies who fall foul of the rules. Many of them don’t fully understand IR35, so they take the instinctive safety-first option of trying to get around it. 

Previously, changes in the public sector caused the NHS to automatically deem all contractors to be inside IR35 and many private companies have done the same thing, but given the delays, they are now more than likely to start engaging contractors via limited companies until 2021 at least. Nonetheless, shifting clients to umbrella companies or using them as employees makes sense from the client’s point of view. Gone are the risks of noncompliance and the work involved with assessing each contractor’s IR35 status. 

In many cases, contractors will be left out of pocket and, with more contractors looking for umbrella companies without fully understanding how they work, we’ve seen a flood of less reputable players coming into the market offering unrealistic savings.

Umbrella companies also suffer from the recent high-profile problems of the loan charge. Before 2016, many contractors were paid in loans which were structured in such a way that they would never be paid back. It was a loophole which meant contractors could avoid paying tax so it shouldn’t have come as a surprise when the Government closed it in 2016 with the Finance Act. 

Some contractors, therefore, may find themselves faced with an unpalatable choice of accepting the umbrella company or voting with their feet and finding work elsewhere in future. If your company suggests you work through an umbrella company you can always say you prefer to work as a limited company. This will involve more complexity and some companies may decide to dig their heels in and insist.  

Making the choice 

If you do go the umbrella company route, it’s important to be careful about your choice. As we mentioned earlier, there may be some companies out there looking to snag careless contractors who don’t understand what they’re signing up to. 

If you work through a recruitment agency, they may have an approved list of umbrella companies that they work with. They should at least be reputable, but that doesn’t mean they offer the best option for you.

Knowledge is vital in this, as in other, situations. You might benefit by working with your client to break down some of their concerns about IR35. If they are insistent, carefully choosing your umbrella company will ensure you at least find the most beneficial way of working possible.

If you are new to contracting and want to learn more about how we can help with your accounting and tax, contact us.

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