Umbrella companies – the truth behind fake take-home pay claims

If you search Google for anything to do with ‘umbrella companies’ or ‘IR35’, you’ll find dozens of ads for seemingly-attractive payment vehicles – aimed at contractors. So how do you know if they’re legitimate or not?

A quick search for many contractor-related terms today (February 2019) will bring back ads above and below the results, with claims such as:

“The best UK umbrella. Take up to 90% after tax”

“Umbrella company – see how much you can take home”

And in the supplementary text on their websites, these companies typically claim to be “100% HMRC compliant”, and “IR35 compliant”.

We’ve noticed a marked increase in this type of advertisement over the past year.

What is a legitimate payment structure for a professional contractor?

If you’re hired as a professional contractor, this will almost always be on a business-to-business basis. So there will need to be an intermediary between you (the contractor) and your client – a limited company.

Contractors very rarely operate as sole traders, and a small percentage are PAYE employees of their agencies.

So, for the vast majority of contractors, you either set up your own limited company or work via an umbrella company (which is a limited company itself; providing payroll solutions for contractors). You can compare the two business structures here.

If you do work via an umbrella company, the only difference in your net take-home pay between one provider and another should be the margin (fee) you pay them.

This is because a legitimate PAYE umbrella company simply processes your pay, after deducting income tax and National Insurance Contributions from your contract earnings. You are taxed in the same way as a traditional payrolled employee.

Government clampdown on tax avoidance schemes

The generic term ‘umbrella’ has been used by a number of non-PAYE payment vehicles in recent years. This can create confusion, particularly for new contractors entering the market – who simply want to use a convenient payroll intermediary.

The Government spends more on tax avoidance now than at any time in the past, but despite this, illegitimate payment schemes are still operating – and the number seems to be increasing.

We suggest anyone thinking of joining an umbrella scheme undertakes as much research as they can before signing up. As the controversial Loan Charge demonstrates, many contractors were hoodwinked by professional advisors to join illegitimate payment schemes in the past, only to face ruinous retrospective tax bills today.

Be aware that HMRC has gone after the users of tax avoidance schemes, not the promoters. Contractors are a far easier target. Over 50,000 individuals have been targeted by the 2019 Loan Charge, some facing six-figure demands for back taxes.

Here are some things to watch out for when looking for an umbrella provider:

Does the company say you can keep 80%, 90% or more of your contract rate after tax?

This would be impossible to achieve legitimately. Corporation Tax is payable on any company profits @ 19%. And after corporate taxes have been deducted, income tax and NICs are payable on your personal income.

The basic rate of income tax in the UK is 20%!

And don’t forget, you also have to pay the umbrella company’s weekly or monthly fee.

Try our umbrella company take home calculator. 64%/65% or somewhere around that mark is a far more realistic take-home percentage for umbrella company contractors.

Other things to look out for

• Does the scheme sound too good to be true (the take-home pay percentage being a key indicator)?
• Does the scheme seem very complex given what you want it to provide you (i.e. a simple way to get paid)?
• Does the scheme claim to have been given the all-clear by a ‘top barrister’, or suchlike?
• Are there any artificial arrangements involved, possibly involving loans, credits or investments?
• Does the scheme claim to save you income tax or national insurance?
• HMRC doesn’t ‘approve’ any umbrella schemes, so any such claims are bogus.
• ‘HMRC registered’ is misleading. This may refer to the DOTAS requirement of tax avoidance schemes.

Tax avoidance schemes – how they pay you

HMRC’s Spotlight 45 provides an example of how tax avoidance schemes work in practice:

• When you are paid, you may receive a small payment, which has some income tax and NICs deductions.
• Simultaneously, or shortly after, you receive a larger payment – with no deductions for tax.
• Often the payments are made from different bank accounts, possibly from overseas.
• Your payslip may split the payments, with the larger amount referred to as something else other than ‘pay’.

By way of contrast, read this article to find out how a legitimate PAYE umbrella company works in practice.

Further Reading

• Try our list of umbrella companies if you’re looking for a new provider/want to change providers.
• Here are some initial questions to ask a prospective umbrella provider.
• Don’t forget – if something sounds too good to be true… it probably is!

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