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Hook, Line and … Tax Debt?


Change presents opportunity…and it’s fair to say that several of my competitors have introduced new types of payroll solutions in light of the up-coming legislation changes in an attempt to “cash in” on that opportunity. Since they’re my competitors, you’ll forgive me if my review of these new solutions isn’t overly positive…but I’ll do my best to substantiate any criticisms that I make, and hopefully that’ll give you a better understanding of why I’m not looking to tread the same path. Before we get started, however, we need to put these new solutions in context by briefly over-viewing the legislation changes that they’re designed to work around.  To do this, we need to look at two different (but interconnected) restrictions that both come into play on 6th April 2016:

1) Salary Sacrifice Restrictions – last years’ Finance Act contained restrictions that will prevent any payroll model that qualifies as a salary sacrifice model from offsetting expenses on an ongoing basis as part of its service (this restriction does not extend to mileage claims). Unfortunately, umbrella solutions as we currently know them qualify as salary sacrifice schemes. This means that come April, the umbrella model as we currently know it essentially becomes little more than an outsourced PAYE payroll model; any expenses incurred by the umbrella employee (with the exception of mileage claims) will need to be offset at the end of the tax year via self-assessment rather than on a weekly or monthly basis each time the worker gets paid by the umbrella company.

2) Travel and Subsistence (T&S) Restrictions – the government are introducing new restrictions that will prohibit many contractors from claiming tax relief on their T&S expenditure if they work via an employment intermediary. Umbrella workers will not be able to claim relief on T&S if they are under supervision, direction, or control (SDC) in the manner in which they carry out their work (this SDC need not be an actual part of the workers daily working practices; the mere contractual right to exert SDC is enough to disallow the claim, even if that right is never actually exercised in practice). Workers using their own Limited company are also in-scope of these restrictions and Limited company workers will not be able to claim T&S if they are caught by the Intermediaries legislation (better known as IR35).

So, if we add 1) and 2) together we get:

3) As of 6th April 2016, umbrella company employees will no longer be able to offset their full range of expenses via the umbrella company on an ongoing basis. They could potentially offset mileage claims on an ongoing basis via the umbrella solution, but that’s only in scenarios where the worker is lacking SDC. Since it appears unlikely that an umbrella employee will genuinely lack SDC, in practice the umbrella will revert to a standard PAYE and any expenses that are allowable will need be offset via self-assessment at the end of the year. So to put it bluntly, the combined effect of 1) and 2) is that contractors will be eligible for less tax relief…and they’ll also have to wait longer for it!

OK, so that’s the new restrictions dealt with…so let’s now take a look at the new models that are intended to work around these restrictions.

First up, we have a revised umbrella solution that’s designed in such a way that it doesn’t meet the criteria of being a salary sacrifice scheme. This means that the model doesn’t fall foul of the salary sacrifice restrictions outlined above…and as such this means it’s potentially “business as usual” in terms of the solution being able to offset expenses on an ongoing basis. The non-salary sacrifice umbrella model is actually quite similar to the standard umbrella model in terms of the overall structure, but where it differs in that it’s much less flexible and fluid.

Under a standard umbrella model the umbrella company assesses the workers expenditure levels on an ongoing basis and offsets them accordingly. This means that in practice the ratio between taxable salary and non-taxable expenses can fluctuate on a weekly basis as the expenditure levels go up and down. Via a non-salary sacrifice model, this flexibility is removed; from the outset the umbrella provider and the worker need to agree a fixed ratio between salary and expenses. This creates an expenses pot which the worker can then get access to on a tax free basis provided that they can demonstrate that they have a legitimate expense to claim against it. Let’s give an example, let’s say Joe Bloggs earns £20.00 per hour on his assignment but he has agreed with his umbrella that he receives £15.00 taxable salary and the remainder goes into his expenses pot. Assuming a 37 hour working week, Joe has an expenses pot valued at £185.00 for each week worked. To get full access to this £185.00 each week, Joe needs to demonstrate expenses to the value of £185.00. If Joe can’t demonstrate any expenses then presumably he loses the money (since he can’t have it back as salary since he’s already received his agreed salary component). If Joe can’t demonstrate expenses to the full value of £185.00 then presumably he’ll lose some of the money from the expenses pot. On the flip side, if Joe incurs expenses which total in excess of £185.00 per week, he can still only get access to a maximum of £185.00 as tax free income and would lose out on tax relief on the additional expenses value.

Obviously it goes without saying that Joe and his umbrella company would need to enter into some sort of assessment process at the outset of the relationship in order to ensure that Joe has a ratio between salary and expenses that will work for him….and presumably that would need to be the case with every worker that comes on board since a standardised ratio that applied to everyone is unlikely to work. I would also assume that this assessment process would need to be revisited for each worker at the start of every new assignment that they undertake since their expenditure is likely to vary on an assignment-by-assignment basis. In my experience, contractors can rarely be precise about the level of expenses they’ll incur before starting on an assignment, so in practice I suspect that these assessments will often lead to instances where the agreed ratio between salary and expenses doesn’t quite work in practice.

A further issue to consider with these non-salary sacrifice umbrellas is that they’ll still be classed as an “employment intermediary” as defined in the legislation concerning the new restrictions around claiming T&S. And when we actually look at the types of expenses currently claimed by umbrella company contractors, the vast majority of the claims are for T&S. So even if a non-salary sacrifice scheme is physically able to offset expenses on an ongoing basis as part of its service, in practice it’s still likely that it won’t be offsetting the most commonly incurred costs due to the vast majority of workers being under SDC. In reality then, will there really be that much of a tax benefit to the non-salary sacrifice umbrella model, or will it actually just turn out to be a really complicated way of achieving the same sort of retention that a worker could expect to receive under standard PAYE (which is exactly what a standard umbrella company becomes from 6th April assuming the worker is under SDC)?

The second type of solution approaches things from a very different angle and basically looks to work around both of these restrictions by offering a model that shores up the workers net retention by giving them access to the flat rate VAT scheme. The model essentially has the same structure as one of the old-style Managed Service Companies (MSC’s) whereby the worker is a director and shareholder of an individual Limited company, but the scheme provider carries out all the administrative work. The key difference, however – and this is necessary to ensure that the MSC legislation isn’t triggered – is that all of the workers earnings are paid to them as employment income rather than a mix of employment income and dividends. In keeping with this “caught by IR35” stance, the model also doesn’t allow workers to claim tax relief on T&S expenses. On the face of it, this model looks to be an effective way of transitioning a large number of former umbrella employees over to having own Limited company status without really asking the workers to take on the normal directorial responsibilities associated with running a Limited company. It also gives them a boost to their net retention because they take home more employment income as a result of the flat rate VAT benefit.

However, other than the scheme provider taking on more control under this solution, it doesn’t really offer anything radically different to the scenario where the worker goes down the normal Limited Company route and then pays themselves as caught by IR35. It’s also worth noting that since this model is being “sold” to agencies in a similar way to which umbrella solutions are, rather than being “sold” to individual workers as per a bona fide accountancy service, you’re likely to get a similar situation arising to the one that we currently get with umbrella companies; namely that contractors will be prevented from using this model on an ongoing basis because not every agency that they work through will like the model or the solution provider in general. The worker will also probably be restricted from taking their Ltd Company away from the scheme provider, or will certainly find it harder to do this compared to a genuine Limited company contractor dis-engaging their accountant. In practice, we may find that contractors get pulled away from this new type of model just like contractors get pulled away from umbrella companies when that company isn’t on the PSL of the agency that has found them their latest role. We don’t get this with bona fide Limited company accountancy services, of course, since agencies do not pull contractors away from their existing accountants (although they may recommend an accountant to someone).

Another point to bear in mind is that this model treats every single Limited Company as caught by IR35. In fact, it ensures that it is impossible for the worker to receive non-employment income (this is presumably done via restrictions introduced in the company’s Articles of Association at the point at which each company is incorporated). Whilst it’s likely the case that the majority of umbrella workers being switched to the new model would in fact be caught by IR35, this is not necessarily the case. Indeed, it’s not even necessarily the case that a worker who is under SDC be caught by IR35, since IR35 assesses a much broader range of factors compared to the narrower SDC test. It’s also the case that workers’ IR35 status could change from assignment-to-assignment based on the specific working practices for each role. The rigidity of this new model has no way of taking that into consideration since it is specifically designed to always treat workers as caught by IR35 in every instance – in fact, it must treat them in this way since this is the only thing that prevents the solution from being in breach of the MSC legislation. A bona fide Limited company accountancy service places no such restrictions on its Limited Company clients and so offers greater flexibility for workers to consider their IR35 status on a case-by-case, assignment-by-assignment basis.

So what will I be talking to contractors and agencies about?

My stance is that deliberate workarounds like those discussed above generally don’t work as well as the scheme provider promises. At worst they may be challenged by HMRC and found not to be compliant in some way, but even if that’s not the case they often have practical problems associated with them (such as the ones I’ve attempted to outline). My thinking is that in times of upheaval, we need to rely on what we know best, not something that’s untried and untested. That being the case, I’ll be continuing to talk about the same portfolio of solutions that are already on the market (standard umbrella services and bona fide Limited Company accountancy services). I suspect I’ll see a shift in the popularity of one compared to the other (I’m already starting to see the beginnings of a larger-scale migration away from umbrella towards Limited Company), but I’m not really seeing any need for new types of solutions to cater for the temporary workers that will continue to need paying come 6th April.

Should any agencies or contractors wish to speak with me, I’d be glad to hear from you.

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