ask the accountant
Temporary workers – better known as contractors – are
now spoilt for choice when deciding if they should operate through
their own limited company, an umbrella or a composite company.
Established contractors are also getting wise to what is on offer.
Should they switch from one umbrella to another? Will they be
better off switching to their own limited company? Andrew Plaskow
is a Partner at Nyman Linden Chartered Accountants and heads
the firm’s UK Contractor Division. He now explains the
implications of each option.
If you are about to leave the ‘safety’ of permanent
employment and venture into the potentially stormy but, nonetheless,
more profitable waters of contracting or freelancing via the
services of TAC Europe, you need to set up your new business
in the best way to minimise your long term tax liabilities, while
maximising your net income and making it easy for your clients
to deal with you.
Not only is this a challenge for first timer contractors but
it is also a subject for review by more and more experienced
contractors seeking a better overall service and net income retention.
In essence, your choice is between setting up a limited company;
or operating under what is called an umbrella service company;
or operating within a composite company. Within each of these
you have hundreds of organisations to select from.
Limited Company – known as a Personal Service Company
(PSC)
For most of you reading this article, the most tax efficient
way to work is through your own limited company (PSC) where you
become a director and shareholder. Basically, your company acts
as an intermediary body between you (the service provider) and
your client (the service consumer). Often there is a consultancy
or agency between you and your client. In your case, it is TAC
Europe. Having your own company is almost like being your own
employment agency. Your PSC effectively acts as your agent and
does not affect your relationship with TAC Europe or your client
in any way. It is very easy to form the company and normally
takes no more than a couple of days to have one in the name of
your choice.
The limited company route has major tax efficient advantages
over all umbrellas and composites:
- 1. You can claim back a wider range of expenses, including
accountancy fees, equipment and software costs
- You can access
a VAT scheme known as the flat rate scheme, which allows
you keep some of the VAT you receive. For example,
with an annual contract income of £50,000, you would
make an extra £1,700. If your contract income reached £100,000,
you would make an extra £3,400 in your first year of
trading.
- Importantly, you have complete control over your
financial affairs.
Contrary to general belief, running your own company is not
difficult and, with the assistance of a good accountant, is no
more challenging than any of the other ways of operating.
Umbrellas
This alternative structure is for contractors:
- Intending only to contract for short periods between
longer phases of permanent employment
- On a contract rate of less than £20 per hour
- Who are on a higher rate but see themselves as financially inexperienced,
probably spending every penny they receive
- Want to be treated as employees
You use the services of an umbrella company
by entering into a contract with it and effectively becoming
a PAYE employee again. The umbrella contracts with your client
or agency. It also takes responsibility for invoicing, paperwork,
collection of money due and payments to you, less tax and National
Insurance deductions.
Although fairly simple to use, umbrellas offer little benefit
for individual contractors in terms of reducing tax liabilities.
Indeed, it normally increases your costs as your umbrella’s
service fees may reach as much as nine per cent of the value
of your contract!
You should also be aware that many umbrella companies insist
on either a minimum level of charging or a minimum time for which
you must pay for their services. By comparison, accountancy fees
for running a PSC are around £1,200 per year, irrespective
of turnover.
If you are thinking of using an umbrella company, you need to
ask them three crucial questions:
1. What exactly will the umbrella charge you?
2. Is there a minimum charge?
3. What tax or accountancy qualifications does their firm possess?
Composites
Finally, there is a third option called a composite company
(CC), where a number of contractors use the same company
through which to bill their services. In essence, it is
a corporate entity, as is a PSC. But unlike a PSC, several
contractors join a single CC and each is issued with one
or more shares of a unique class. This is done to match
dividends to individual earnings. The CC contractor finds
his own work and lets the CC provider know of his hours
worked and the fee rate so that invoicing and VAT can be
processed and all accounting and administration tasks can
be dealt with. With regard to VAT, whereas the highly lucrative
Flat Rate Scheme is commonly used by PSCs, it is not available
to CCs.
It is the provider of the CC, not
the contractors, who is the director of the CC. The provider
is normally the director of all the CCs it creates – with
each CC restricted to one producing no more than £300,000
in taxable profits so that the corporation tax rate remains
19%.
Each contractor is paid a wage at an annual rate equal to
a personal allowance. From his contract income, the provider
deducts its administration fee and enough funds to cover
corporation tax on the profits. The balance of each contractor’s
income to the CC is distributed to him as a dividend on his
share, normally on a monthly basis. However, because the
contractor is not a director, the CC has to pay at least
the National Minimum Wage and this will cost quite a bit
in NIC. For a 40 hour week, pay needs to increase to just
over £10,000 costing £1,302 in NIC. Such inflexibility
does not exist with a PSC.
In terms of your ability to maximise your income, forming
a limited company is the most attractive option allowing
you typically to take home over 80 per cent of what you earn.
This well exceeds umbrella services and composite companies
where you will expect to take home approximately 65 per cent
and 73 per cent of your earnings respectively.
Expenses
Whatever you may hear to the contrary, you can only claim
expenses for items you have actually purchased. This is true
for PSCs, umbrellas and composites. It is unfortunate that
many umbrella and composite companies refer to 'special dispensations'
in their marketing blurb, implying you can claim more expenses
by using their services. Any good accountant will tell you
such claims are nonsense because expenses can only be either
allowed or disallowed by reference to Tax Law - not by reference
to the company you use to calculate your payroll.
Checklist
As a professional tax advisor with many years providing
services to contractors, I want to share with you a sensible
checklist of what to look out for when deciding the structure
that will be best for you:
1. Beware of strongly marketed but unregulated tax service providers
offering one solution as the only option for all contractors
2. Be wary of service providers who make themselves out to be
licensed but are most certainly not
3. Be suspicious of companies making extreme service claims and
promising excessive take home pay
4. Question these companies’ ‘dispensation agreements’ on
expenses that they have with the Inland Revenue because these
can only ever be realised by individuals in exceptional circumstances
5. A professional tax advisory service would not ask you to rely
on help desk support or a team of people where you do not know
who you are talking to and every time you call it’s a different
person answering. In these scenarios, you are buying scripted,
generic advice that can never be precise and applicable to you.
Why should you accept mediocrity and take advice from unqualified
staff?
6. Demand a highly personal, bespoke service – naturally,
at a competitive fixed fee - because your precise needs and expectations
of the accountancy service you require are always going to differ
from your colleagues.
7. Choose a professional firm that is fully regulated by any
of the Chartered Institutes so you can be certain of the advice
given and very comfortable in following it. No Chartered firm
would ever knowingly endorse tax structures and positions that
could to fall foul of the law.
Conclusion
Ultimately, your choice of structure will be determined by your
individual needs.
For most contractors, the most trusted, tax efficient and cost
effective way to legally operate is still through a personal
service company – whether you are in or out of IR35.
Questions can be addressed either by letter or by email to: ‘Ask
The Accountant, c/o The Editor at intouch (email: intouch@taceurope.com).
We regret that we are unable to respond to unpublished letters
and, in order to facilitate publication, letters may be edited.
Nyman Linden is a highly respected firm of Chartered Accountants
who specialise in provide advice to individuals working on a
freelance basis. For further information about their services,
call 020 7535 1500. Nyman Linden, TAC Europe and their respective
employees cannot be held responsible for any actions undertaken
as a result of the opinions expressed in this feature. As individual
circumstances vary, you are advised to seek individual expert
advice.
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