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IR35 private sector reforms: IT contractors warned to be wary of non-compliant umbrella companies

The proliferation of websites offering comparison site-like services for umbrella companies has prompted tax experts to warn IT contractors of the financial risk posed by firms offering ‘too good to be true’ take-home pay rates

A surge in the number of umbrella company comparison sites offering “too good to be true” take-home pay rates has reignited concerns that the incoming IR35 private sector reforms could result in more IT contractors facing life-changing tax bills in years to come.

The reforms will see contractors cede control for determining how they should be taxed to the medium-to-large private sector firms that engage them from 6 April 2021, as part of a multi-year clampdown by HM Revenue and Customs (HMRC) on tax avoidance in the self-employed sector.

Some private sector firms have sought to swerve this responsibility by opting out of using limited company IT contractors, and issuing guidance that states they will only engage contractors that work for them via a pay-as-you-earn (PAYE) umbrella company.

Signing up to an umbrella company typically requires the contractor to cease trading as a limited company and become the umbrella’s employee. As such, the end-client is no longer required to determine how the contractor should be taxed, because they will already be on the umbrella company’s payroll.

This way of working has some advantages for contractors. For example, it means they can offload the day-to-day admin that comes from running a limited company to the umbrella, which also assumes responsibility for invoicing end-clients on the contractor’s behalf and ensuring the correct employment tax deductions are taken from their gross pay. These include national insurance contributions and PAYE tax, and the umbrella company will also charge admin fees.

However, there are umbrella companies out there that claim the contractors on their books can take home more than 85% of their gross pay. Although such high net pay rates are sure to be attractive to some, contractors are advised to steer well clear.

Such high rates of take-home pay are difficult to achieve without some form of creative accounting, which means the umbrella company could be employing disguised remuneration techniques to minimise the amount of tax its employees (the contractors) have to pay.

“What you are looking for is generally any mechanism that splits a contractor’s income into two different payments – one small amount that is taxable and the remaining larger amount as something non-taxable, such as a loan, annuity, benefit trust,” said Julia Kermode, founder of independent worker consultancy IWORK.co.uk.

“This type of arrangement is generally disguised remuneration because a portion of your taxable income is disguised as something else.”

By agreeing to participate in a setup like this, contractors could be putting themselves at significant personal financial risk, said Kermode, and could end up with a large bill for unpaid tax, courtesy of HMRC, later down the line.

“You don’t need to be a tax expert to spot an avoidance scheme,” said an HMRC spokesperson. “Anything that sounds too good to be true almost certainly is, and anything that claims you can take home 90% of your pay, or asks you to sign up to loans from an offshore trust just so you can be paid, is something to steer clear of.

“That’s why we are encouraging taxpayers to steer clear of tax avoidance schemes as part of our wider work to make it much harder for promoters to operate.”

Prohibition of promoters

HMRC has embarked on a much-talked-about clampdown on the promoters of tax avoidance schemes and has issued guidance to contractors on how to make sure the umbrella company they are dealing with is tax-compliant.

Despite this, new schemes and non-compliant umbrella companies continue to emerge, as promoters look to cash in on the fact that the private sector IR35 reforms are likely to see a surge in the number of contractors needing to work through umbrella companies.

“This seems to have given these non-compliant organisations renewed impetus to advertise their services,” Seb Maley, CEO of insurance provider Qdos Contractor, told Computer Weekly. “Many contractors, after all, are worried about the incoming changes and are exploring their options.

“These schemes continue to advertise unrealistic take-home percentages – some even up to 84% after tax. This is far too good to be true or, in any case, compliant.”

While the problem of non-tax-compliant umbrella companies is seemingly nothing new, the tactics that the promoters of these setups are employing do seem to be changing, perhaps in response to HMRC’s efforts to clamp down on the proliferation of tax avoidance schemes.

One new tactic that promoters are favouring is positioning themselves as purveyors of comparison site-like services that can help contractors “shop around” for umbrella companies offering the most competitive rates of take-home pay.

One of these firms, trading as Contractor Planet, markets itself as a “no-obligation comparison” service that offers contractors the chance to “retain what you deserve from your take-home pay” by connecting them with the “best available umbrella deals” on the market.

“Switch to one of our umbrella companies and boost your take home by £1000s a year,” said one of its marketing emails, forwarded to Computer Weekly.

The umbrella companies it claims to represent are described as being “agency approved” and “HMRC-IR35 friendly”, while its website claims that its “umbrella deals” can help contractors “retain up to 85% of their contract’s value”.

Computer Weekly contacted Contractor Planet to request details of how the umbrella companies on its books are able to offer such high rates of take-home pay while operating within the law, and was told that the company “does not make comment to the press”.

Computer Weekly has been supplied with details of half a dozen firms offering similar services, all of which claim that contractors can take home upwards of 80% of their gross pay by using their respective comparison site services to secure better, more competitive pay rates. But they are not all they seem, said Qdos Contractor’s Maley.

“A number of these schemes now mask themselves as comparison websites, no doubt to draw contractors in under the illusion that the website will search for the best deal on the market. But this isn’t the case,” he said.

“There is no comparison done, with these websites leading you to the same one provider of the non-compliant scheme. The comparison aspect is a tactic used to create a false sense of legitimacy and no doubt to make it even harder for HMRC to track them down.”

Incidentally, HMRC published guidance back in April 2020 warning people off using umbrella “brokerage” or “comparison site” services, because it had evidence to suggest that this approach was being used to introduce contractors to non-compliant tax avoidance schemes.

Protecting contractors

A recent survey by contractor tax compliance company IR35 Shield polled about 3,000 contractors, and 60% of respondents said they regularly found themselves on the mailing lists of umbrella companies offering similarly “too good to be true” take-home pay rates.

Speaking to Computer Weekly, IR35 Shield CEO Dave Chaplin said that even with the threat of enforcement action from HMRC, the proliferation of these problematic schemes is likely to increase, and the financial risk they pose to contractors will remain high.

“In our survey, 60% told us that they either regularly or occasionally received marketing from payroll companies offering unrealistic take-home pay of roughly 85%, and 74% said they were unable to distinguish between a compliant umbrella company and a tax avoidance scheme.” 

On this point, there are many examples of contractors falling foul of HMRC’s tax avoidance rules after discovering that the umbrella company they joined was paying all (or part) of their salary to them in the form of non-taxable loans.

Similarly high rates of take-home pay were offered as an incentive for people to join, but participants in these schemes have since found themselves pursued by HMRC for huge sums of unpaid tax through the agency’s controversial, retroactive Loan Charge policy.

As previously documented by Computer Weekly, these loan remuneration schemes were often marketed to contractors by tax advisers who assured participants that they were a compliant way of retaining more of their take-home pay – and the schemes continue to be positioned in this way.

For this reason, IWORK.co.uk’s Kermode is of the view that the tax adviser community should be more tightly regulated, given the role some of its members have historically played in the Loan Charge saga.

“I would like to see a similar level of oversight as we currently have for mortgage and pensions advisers,” she said. “We have seen how effective regulating those advisory professions has been in recent years, and it seems remiss that tax advisers are not regulated.

“It effectively means that individuals have no mechanism for seeking redress, and it also means that the government expects all taxpayers to be ultimately responsible for their own tax affairs. However, tax legislation is notoriously complex, hence so many differing legal views on some of the detail, so surely this expectation is unreasonable, to say the least.”

Read more about IR35 and umbrella companies

The Loan Charge policy has been linked to at least seven suicides, and has taken a huge toll on the mental health and wellbeing of contractors found within its scope, and should serve as caution enough for those considering joining non-compliant umbrella companies, said Kermode.

“The financial impact on individuals caught in the scope of the Loan Charge policy has been devastating,” she added. “Often they are completely unaware that they are in a scheme until they receive a six-figure tax bill from HMRC, which is an unaffordable and life-changing amount for most people.”

Crawford Temple, CEO and founder of payment intermediary compliance company Professional Passport, echoed Kermode’s calls for more regulation, but said work also needed to be done urgently to prevent another wave of contractors ending up in HMRC’s crosshairs once the roll-out of the IR35 private sector reforms takes place.

“New legislation and additional regulations have had some success in reducing the volume of schemes, but I would urge the Treasury and policy-makers to take a different stance and work more closely with stakeholders throughout the [labour] supply chain,” Temple told Computer Weekly.

“We need a collegiate approach to bring the market together to defeat these avoidance structures once and for all. It is more pressing than ever that we work quickly and efficiently to limit the access to market for non-compliant providers.”

Temple added: “It is vital that we continue to educate the whole supply chain to look carefully at the credentials of a provider claiming to be an umbrella firm and understand what is really being offered. It is this detail that will determine if it is an umbrella company or a ‘have I got a good idea for you’ scheme and best avoided.”

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