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IT contractors could end up saddled with huge, life-changing tax bills by joining legitimate-looking umbrella companies for IR35 compliance reasons that are not all they seem, experts warn.
The claim comes in the wake of a letter-writing campaign by HM Revenue & Customs (HMRC), directed at public sector contractors, that suggests recipients have sought to avoid paying tax by being paid for work they have done previously in the form of a non-taxable loan.
The letters, seen by Computer Weekly, claim recipients are yet to reach a settlement with HMRC to cover the amount of tax they owe as a result of opting to be remunerated in loans, rather than a conventional salary.
Computer Weekly understands that a sizeable proportion of recipients claim they have never knowingly opted to be paid in this way and were unaware – until receiving one of these letters – that they had been dabbling in what HMRC terms "disguised remuneration".
And while it would be easy to write-off their protestations as something anyone would say who had been caught doing something they should not be, MPs, tax advisors and other assorted contracting stakeholders all share the view these complaints have merit.
Recipients of these letters are known to include public sector IT contractors, as well as teachers, NHS workers, and social care providers too, and HMRC confirmed in a statement to Computer Weekly that all of them will be registered on its systems as users of “disguised remuneration schemes”.
Some of the recipients on HMRC’s mailing list may have knowingly joined these schemes, but it’s claimed there are many others who will have done so without realising, by joining umbrella companies that did not openly disclose that participants would be paid in loans.
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Computer Weekly understands that many of the letter recipients were moved to join umbrella companies in the spring of 2017, as HMRC geared up to extend the IR35 tax avoidance reforms to the public sector.
The reforms saw public sector contractors relinquish responsibility in April 2017, for determining how they should be taxed to the government agencies, NHS trusts or local authorities, for example, who hired them.
As such, it became the responsibility of public sector bodies to decide if the contractors they engaged should be taxed in the same way as permanent employees (inside IR35) or as off-payroll (outside IR35) workers, based on the work they do and how it is performed.
To ensure compliance with the reforms, some public sector bodies are known to have made blanket determinations that resulted in large numbers of contractors being declared inside IR35.
In that scenario, contractors are often advised to cease providing services to end clients via their own limited companies and join an umbrella company. This is because they will have to pay a similar rate of employment tax and National Insurance as a permanent employee would anyway.
The contractor pays the umbrella company a fee to take care of all the admin and accounts work they would have previously done themselves while operating as a limited company. To that end, the umbrella operator will also assume responsibility for invoicing the client on the contractor’s behalf and ensuring the correct employment tax deductions are taken from their salary.
In instances where umbrella companies pay participants in the form of a tax-free loan, the contractor will still be relieved of all the above administrative burdens in exchange for a percentage of their salary.
Now, if that sum is similar in size to the amount of money a contractor expects to have deducted in tax and company fees from their salary by the umbrella, there is a chance they may not notice they have joined a loan scheme as their take home pay remains the same.
“Schemes popped up all over the place in the wake of the IR35 reforms, and contractors without a firm grip of tax law were unwittingly being misled into using them,” Dave Chaplin, CEO of IR35 consultancy ContractorCalculator, told Computer Weekly. “There is simply no way a compliant payroll firm can offer a tax saving [to employees] because the contract rate must be treated as employment income – and every payroll firm has to follow the same tax laws.”
According to data from the Association of Professional Staffing Companies (APSCo), the 2017 reforms coincided with a drop in the number of contractors who provided services to public sector organisations through limited companies, as many opted to work through umbrella setups instead.
The difference between good and bad umbrella companies
And while there are a great number of reputable umbrella companies out there, there are plenty of others that are acting as a front for loan-based remuneration schemes, without necessarily disclosing to participants that they are being paid in loans, it is claimed.
“Many people are only just finding out now they were put into loan schemes,” Sir Ed Davey, MP and co-chair of the Loan Charge All Party Parliamentary Group (APPG), told Computer Weekly. “It is deeply concerning that many public sector workers are now receiving letters from HMRC, which is causing huge anxiety for many nurses, doctors, social workers, teachers and other key workers.”
And with the government gearing up to extend the IR35 reforms to the private sector in April 2020, there is real risk that another tranche of contractors will fall into a similar trap this time around too, warned Dr. Iain Campbell, secretary general of the Independent Health Professionals Association (IHPA), whose members include locum doctors and NHS workers.
“Our organisation has been contacted by a flurry of panicked members who have received letters from HMRC after they were mis-sold umbrella loan arrangements as a consequence of the public sector off-payroll [IR35] reforms,” he told Computer Weekly.
“We have been warning of this link for some time and are worried that [the] private sector roll-out of these reforms is likely to cause yet more workers to be mis-sold such arrangements.”
As was the case in the public sector, the lead up to the private sector reforms coming into play has seen many firms issue blanket bans on the use of limited company contractors or declare that all their off-payroll workers are inside IR35.
For this reason, it is likely there will be a similar surge in the number of contractors joining umbrella companies in the coming months too, said Andy Chamberlain, deputy director of policy at the Association of Independent Professionals and the Self-Employed (IPSE).
“Lots of people are going to be pushed into working through umbrella companies whether they like it or not. And while many umbrella companies are perfectly complaint organisations, there are others that are not and some of them have promoted some of these disguised remuneration schemes,” he said.
“There is a real risk that people are going to be pushed into these [non-compliant] umbrella companies because of the IR35 private sector rollout and get themselves somewhat unwittingly involved in a disguised remuneration schemes that the government many come along at a later date and say they don’t like.”
To avoid such a fate, it is important that IT contractors do their research into any umbrella company they are thinking about signing up with, said ContractorCalculator’s Chaplin.
There are several trade associations – including the Freelancer and Contractors Services Association (FCSA) – that carry out “in-depth quality control processes and audits” on umbrella companies, he said, so it is worth checking first if a prospective umbrella company has been vetted by one of them.
There is no requirement for umbrella companies to submit themselves for auditing by trade associations, and there are other background checks that IT contractors should also do to ensure the umbrella they are evaluating is compliant with UK tax laws, he added.
“Contractors who wish to ascertain whether any payroll scheme is [tax] compliant or not can simply go into Google and type ‘salary calculator’ to understand [how much tax] they should be [paying]. Under the new [IR35] rules, the rate paid to the contractor must be treated as employment income – which means just the same as a permanent salary,” he said.
“Secondly, they can ask [the provider] for a Key Information Document and a detailed tax illustration, and check that against the standard salary calculation.”
It is also important that IT contractors receive a full and transparent breakdown of all the deductions the umbrella company will be taking from their salary to ensure their money is going to the taxman as assumed, Chaplin added.
“They need to be careful not to assume take home pay being what they would expect under a salary to indicate the correct tax has been paid,” he cautioned.
Clamping down to protect contractors
According to HMRC’s own figures, there were more than 6,000 first-time loan scheme users recorded in the wake of the public sector IR35 reforms during the 2017-18 tax year, which is the highest rate of enrolment since records began. And a further 3,000 individuals signed up during the first half of the 2019-2020 tax year too.
As a result, these individuals have now found themselves pulled into the scope of HMRC’s controversial loan charge policy, which has left thousands of IT contractors saddled with life-changing tax bills relating back to work they did between 9 December 2010 and 6 April 2019.
The HMRC letters to public sector contractors are designed to make them aware of this, while also notifying them of a series of changes that have recently been made to the policy, in the wake of a recent independent review into it by ex-National Audit Office comptroller Sir Amyas Morse.
The review itself confirms the market conditions that enabled loan schemes to thrive still exist, and the government said in its response to its findings that more will be done in due course to clampdown on companies and individuals who promote loan-based remuneration schemes.
So while there are steps that IT contractors can take to protect themselves from inadvertently falling into tax avoidance schemes, the onus should be on HMRC and the government to ensure they are doing all they can to stamp out these bad actors, said Steve Packham, a spokesperson for the Loan Charge Action Group (LCAG).
His organisation is actively campaigning for all retrospective elements of the loan charge to be scrapped, meaning the policy would only affect individuals who entered schemes after the policy came into effect in April 2019.
Loan charge scandal
The letters being sent out to public sector workers constitute another phase of the “loan charge scandal” and highlight just how the policy’s impacts are continuing to be keenly felt across the self-employed sector, he added.
“[This] shows the issue is far from being resolved and at the same time we know that schemes are still being promoted and the government and HMRC are doing nothing to prevent this,” said Packham.
A relatively easy win on this front would be for the government to act on the discussions it has had in the past about the importance of ensuring umbrella companies are properly regulated, said IPSE’s Chamberlain.
“They [the government] said they thought this is a good idea, and that they were going to work towards doing it, but they've basically done nothing about it,” said Chamberlain.
For instance, there was recommendation made to regulate umbrella companies in the government-commissioned 2017 “gig economy” review by former Tony Blair advisor Matthew Taylor. It made the case for umbrella companies to be covered by the Employment Agency Standards legislation, which exists to protect the rights of agency workers.
Umbrella and loan scheme link
The Morse review also highlights the link between umbrellas and loan schemes, while rightly stating that it was “always possible” for individuals to work via an umbrella without joining a loan scheme.
Even so it also claims that, during the compiling of the review, Morse “saw evidence of loan schemes being sold as part of a package alongside employment through umbrella companies, merging two distinct concepts”.
Given the number of public sector contractors who have found themselves registered on HMRC’s systems as participants in disguised remuneration in the wake of the public sector IR35 rollout, this is another reason why the government should hold off on repeating this process in the private sector, said Chamberlain. At least until umbrella companies are subject to regulation.
“It would be a sensible move [on the government’s part] to regulate umbrella companies to try and stamp out this poor practice because we know for a fact that more people are going to be pushed into these structures as a result of the private sector IR35 reforms. And that will almost certainly lead to tax avoidance, and even tax evasion,” he said.
“It would be much better if the government hit pause on IR35, got the umbrella companies sorted, and maybe looked at an alternative model to IR35. And if they can’t find [an alternative], at least they have regulation in place before it goes ahead.”
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