Contracting in the UK: IR35 and Umbrella Companies

According to research conducted by the Small Business Research Centre at the Kingston University, there are approximately 1.4 million freelancers and contractors in the UK, of which roughly 58 percent freelance “full-time”. The number of contractors in UK has increased by 14 percent since 1998. Additionally, 160,000 people freelance in addition to their main jobs. One reason for this spurt in freelancers is the internet, which has enabled contractors to find better paying work, faster.

Contracting in the UK and IR35 Legislation

Every contractor in UK must be familiar with the IR35 legislation, which was introduced in 2000 exclusively to tax “disguised employment” – i.e. contractors and freelancers. As per the IR35 legislation, the HM Revenue & Customs treats a contractor as an employee of the client for tax purposes. In real world terms, this translates into higher taxes and more National Insurance Contributions.

The financial implications of the IR35 can be severe for most contractors, especially contractors who do not work under the cover of a limited company. Freelancers who work part-time, or contractors who often see long gaps between contracts are the most affected by this legislation.

To lessen the financial burden of the IR35 legislation, a contractor can either opt to form a limited company, or join an umbrella company. The former option is more expensive and suitable only for contractors who deal with large projects and see hundreds of thousands of pounds in turnover. The latter option (joining an umbrella company), is more suitable for the majority of contractors who have neither the turnover, nor the time for managing a limited company.

Umbrella Companies Explained

An umbrella company essentially acts as an intermediary between the contractor and the client. The client pays the umbrella company, which deducts all possible tax liabilities and a small token fee, and forwards the payment to the contractor.

Umbrella Companies

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By joining an umbrella company, you essentially reap the benefits of working as a full-time employee, while enjoying the freedom and financial incentives of a contractor. The umbrella company, in effect, becomes your ’employer’. Most reputed umbrella companies offer many benefits, including health insurance, holiday and sick pay, pension schemes, etc.

Umbrella companies withhold taxes as per the HMRC PAYE (Pay-As-You-Earn) scheme. When you hand in the finished work to the client, the client can forward the payment to the umbrella company, which withholds any required taxes along with its monthly/transaction fee (usually capped at £25 per week), and remits the remainder to you.

Umbrella companies can also take care of any required paperwork and offer financial advice to make the most of your contracting career. They handle the accounting, finance management and legal work associated with a contracting job, making it easier for you to focus on your work and maximizing your income potential.

Joining an umbrella company is a more flexible and affordable option for contractors in the UK who do not have the time or the resources to form a limited company. It is the ideal solution in these troubled economic times where saving money on taxes and NIC costs is vital to the survival of any business.

David webster is a trainee accountant who has been interested since he was bought some shares as a kid. He now follows all things financial and trades forex for fun.

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