Umbrella or Personal Service Company?
Contractors working through an umbrella company are unable to claim tax relief on travel and subsistence if they are subject to Supervision, Direction or Control (SDC). The change in legislation came into place on the 6th April 2016. With a large majority of umbrella workers previously claiming travel and subsistence, it goes without saying that their take-home pay is almost certainly going to be lower than before the legislation changes. This has sparked much debate as to whether umbrella employees are now better off leaving their umbrella payroll provider, and starting their own Personal Service Company (PSC) – to “increase tax efficiency”. We have noticed a number of service providers pushing contractors in the direction of starting their own limited company, but has each contractor’s personal circumstances been taken into account? It is important to ensure that starting a PSC is not just a “quick fix” and it should be a sustainable option for you now and in the future. Are you aware of the potential pitfalls that might catch you out?
SDC and IR35
Supervision, Direction or Control (SDC) does not apply to Personal Service Companies (PSC) yet. However, setting up a limited company will not automatically bypass the restriction on relief for home to work travel and subsistence, unless the contract is genuinely outside of IR35. This is because travel and subsistence expenses are restricted by your IR35 status. If you are working as a limited company and the contract you are undertaking falls inside IR35, you are still unable to claim this tax relief.
SDC and IR35 are different legislations. Nonetheless, if you are subject to SDC with an umbrella, it is more than likely you will run into difficulty with IR35 as well.
The effect of being caught inside IR35
Apart from the restriction on relief for home to work travel and subsistence, contractors that are caught by IR35 will also need to perform a deemed payment calculation (i.e. up to 95% of the contract income will have to be treated as if the company is employing the contractor under PAYE). This will effectively level out most of the financial advantage of incorporating a Personal Service Company over using an umbrella company under SDC.
Please note that for every new contract, your IR35 status should be reviewed to determine your status.
Things to consider before incorporation
Apart from the financial reasons, we strongly recommend that contractors consider other non-monetary factors before deciding to start a Personal Service Company and becoming a company director, which comes with statutory obligations. For more information, please read our ‘Limited v Umbrella’ summary.
Umbrella companies look after you
Providing your umbrella company is reputable and highly accredited, you will be looked after. For a small weekly/monthly fee, the administration that comes with your contract will be taken care of, and you will be employed directly by the umbrella. This means you are entitled to full employment rights, including SSP, SMP/SPP and holiday pay. A majority of umbrella companies offer full employment insurance throughout your assignment. There are a host of other benefits that come with using an umbrella company, please read ‘Employee Benefits‘. The umbrella option is still considered to be the most “hassle free” way to contract.
So now back to PSC – is the extra work worth the hassle?
A limited company may have its financial edge due to the 5% allowance on deemed payment, the ability to register for VAT and the potential of utilising the VAT Flat Rate Scheme. However, please beware that setting up a limited company and all the relevant HMRC registrations can be time-consuming. There will be costs involved to get going because of legal and accountancy fees. Therefore, a limited company may not be the best option for a short-term contract.
If you are the director of a limited company, we strongly suggest you have a good accountancy firm looking after your books. This way, there are unlikely to be any nasty surprises throughout the lifespan of the company. For example, meeting statutory filing deadlines – these are a constant requirement, even if your company is dormant. If these are forgotten about, you could face penalties and surcharges from HMRC and Companies House.
Let us help you make the right decision
An umbrella company could be the simplified way for you to operate as a contractor and will help you avoid the dreaded administration work, whilst reaping the benefit of being a full-time employee. On the other hand, a PSC gives you more flexibility where applicable, the opportunity to be your own boss and benefit from the potential financial edge and business development opportunities.
We understand that everybody’s personal circumstances are different and we are urging any contractors who are unsure what the best option for their working future is, to give our team a call. K&B Accountancy Group and Cloud9 Umbrella are specialists in the freelancing industry, offering an accountancy service for limited company clients and an umbrella option for contractors. We are on hand to offer impartial and expert advice.
To take advantage of our free initial consultation, please contact: