IR35 is a crucial piece of legislation that affects contractors and freelancers in the UK. However, when it comes to umbrella company employees, there is often confusion about whether IR35 applies. In this article, we will break down what IR35 is, how it applies to different working arrangements, and whether umbrella company employees need to worry about it.
IR35 is a tax law introduced in 2000 to prevent tax avoidance by individuals who provide their services through an intermediary, such as a personal service company (PSC), but who would be classed as employees if engaged directly. The legislation ensures that such individuals pay the correct tax and National Insurance contributions (NICs) as if they were employees.
IR35 applies mainly to self-employed contractors who work through their own limited companies. If a contractor falls inside IR35, they must pay income tax and NICs similar to a regular employee. If they are outside IR35, they can benefit from tax advantages that come with operating through a limited company.
An umbrella company is an organisation that employs contractors and freelancers, managing their payroll and tax responsibilities. When working through an umbrella company, a contractor effectively becomes an employee of that company. The umbrella company processes their pay via PAYE (Pay As You Earn), deducting income tax and NICs before paying them their salary.
No, IR35 does not apply to umbrella company employees. This is because:
Employment Status: An individual working through an umbrella company is considered an employee of the umbrella company. Since IR35 only applies to contractors working through their own limited companies, it does not affect those in umbrella arrangements.
PAYE Taxation: Umbrella companies deduct tax and NICs at source through PAYE, meaning there is no opportunity for tax avoidance in the way that IR35 is designed to prevent.
Legal and Tax Compliance: Because umbrella company employees are already treated as employees for tax purposes, their earnings are fully subject to income tax and NICs, making IR35 irrelevant in this case.
No, umbrella companies do not determine IR35 status. IR35 applies to contractors working through their own limited companies, whereas umbrella company employees are already taxed under PAYE. The responsibility for IR35 determination lies with the end client or agency for limited company contractors, but it is irrelevant for those employed by umbrella companies.
The confusion often arises because contractors who switch from a PSC (personal service company) to an umbrella company may have previously been concerned about IR35. However, once they become umbrella employees, IR35 is no longer relevant to them.
Some employers and recruitment agencies may still mention IR35 in job descriptions, even when engaging umbrella contractors, leading to unnecessary concerns. However, once a contractor is inside an umbrella company, their tax status is clear—they are an employee, and IR35 does not apply.
| Feature | Limited Company (PSC) Contractor | Umbrella Company Employee |
|---|---|---|
| Employment Status | Self-employed | Employed by the umbrella company |
| Tax Handling | Responsible for own taxes | PAYE tax deducted at source |
| IR35 Consideration | Must determine IR35 status | IR35 does not apply |
| Admin & Paperwork | High (invoicing, tax returns, etc.) | Low (umbrella company handles admin) |
| Take-Home Pay | Can be higher if outside IR35 | Lower due to PAYE deductions but more straightforward |
If you are working through an umbrella company, you do not need to worry about IR35. The key reason is that IR35 is aimed at those who operate through their own limited companies to determine if they are effectively disguised employees. Since umbrella company employees are already taxed as employees through PAYE, IR35 simply does not apply.
With numerous umbrella companies in the market, it is essential to choose a reputable one. Look for:
1. Can I still be considered self-employed if I work through an umbrella company?
No, when you work through an umbrella company, you are legally an employee of that company. This means you are not self-employed and do not operate as a business owner. Your pay is processed via PAYE, and employment rights such as holiday pay and sick pay apply.
2. Why do some recruiters still mention IR35 for umbrella company contracts?
Many job descriptions and contracts still reference IR35, even when the role is only available through an umbrella company. This is often due to outdated terminology or confusion about tax rules. If you are employed by an umbrella company, IR35 does not apply to you.
3. Is an umbrella company better than a limited company for avoiding IR35 risks?
Yes, because IR35 only affects contractors working through their own limited companies. By working through an umbrella company, you remove any IR35 risk since you are already paying taxes like a regular employee.
4. Are there any financial disadvantages to using an umbrella company?
While using an umbrella company simplifies tax management, it can mean lower take-home pay compared to working outside IR35 through a limited company. This is because all earnings are taxed at source, and you do not benefit from tax efficiencies available to PSC contractors.
5. Can I claim expenses if I work through an umbrella company?
This depends on whether your umbrella company offers an expenses policy. Since April 2016, contractors under supervision, direction, or control (SDC) cannot claim tax relief on travel and subsistence expenses. However, some umbrella companies allow legitimate work-related expenses to be processed through their payroll.
6. How do I know if an umbrella company is compliant with tax laws?
A compliant umbrella company will operate PAYE correctly, provide full payslips, and ensure all tax deductions are made according to UK employment law. Be cautious of umbrella schemes that offer artificially high take-home pay, as these may involve tax avoidance arrangements that could lead to legal issues.
If you are working through an umbrella company, you do not need to worry about IR35. The key reason is that IR35 is aimed at those who operate through their own limited companies to determine if they are effectively disguised employees. Since umbrella company employees are already taxed as employees through PAYE, IR35 simply does not apply.
For contractors considering whether to work through a PSC or an umbrella company, the choice depends on personal circumstances, administrative preferences, and financial goals. If you want simplicity and to avoid IR35 concerns, an umbrella company could be a good option.
Understanding tax laws and compliance is essential for any contractor. If you are unsure about your tax situation, consider seeking advice from a professional accountant or tax specialist to ensure you make the best decision for your contracting career.