The introduction of the rules outlined in IR35 reduced the range for higher paid workers of businesses to set up as contractors (still working for the same company) by creating limited businesses and drawing little salaries and taking the majority of the revenue as dividends, decreasing their tax and National Insurance payments. Effectively, IR35 set up a number of tests to determine whether or not an individual is a genuine contractor or a disguised worker of the company they are working for (client company).

When a contractor consents a contract with a client company, whether or not it’s directly or through a recruitment agency, there are risks that it might fall within the range of IR35 and the contractor may be treated for tax purposes as an employee from the client company.

This is where the Umbrella company comes into play. The contractor is (or becomes) an employee of the Umbrella company who will bill the client company (or recruitment agency) for the many hours worked and then any legit costs incurred. On payment being received by the Umbrella company they will compensate the contractor, deduct and take into account tax and National Insurance. The costs will be looked at when calculating the pay, tax and National Insurance for the contractor.

Contractors whom acquire work via hiring agencies have marginally different agreements. You will find extra steps in the process that entails the agency is invoiced via the Umbrella company, the agency bills and is paid off by the client company and the agency subsequently will pay the Umbrella company.

Contractors doing work for an Umbrella company can show that they are definitely not an employee of the client company and consequently don’t fall foul of the IR35 rules. The Umbrella company bills the contractor a fee for the provision of their expert services and this is an allowable expense for tax reasons.

A good example of just how a contractor is compensated through an Umbrella company works is best shown:

Contractors that don’t work through Umbrella companies have to handle all of the extra paperwork, deal with the invoicing plus account to HMRC for tax and NI. Additionally they could face investigation with regard to the breach of IR35 rules. Suspected breaches of IR35 rules are complex and really expensive to defend.

Even if you successfully show that you simply haven’t breached the IR35 rules, you can’t recover the expenses you’ve incurred.

Umbrella Company And IR35- A Fundamental Guide is a post from: WiredWriter