Moving from a PSC to an umbrella: is it worth it?
In wake of the April 6th clampdown on limited companies, it’s no surprise that contractors supplying the public sector are asking whether they should consider moving from their PSC to an umbrella company, writes Martin Hesketh, the chief executive of Brookson Group.
Private sector contractors
For individuals working solely within the private sector or via consultancy businesses who provide services (rather than labour) to the public sector, the changes coming into effect from April will have no major impact. The only potential consequence is that there could well be an influx of contractors moving over to the private sector from the public sector in order to preserve their income, making the demand for each job even more competitive.
Therefore, contractors who work through their own PSC may continue to do so with minimal disruption.
The responsibility of determining IR35 status will continue to lie with the individual contractor and they should therefore continue to get regular IR35 reviews to ensure they are complying with the legislation and are taxed accordingly.
Public sector contractors
If the contractor intends to work solely in the public sector, on assignments which are likely to be subject to the new IR35 rules, and take-home pay is their sole driver for using a company for their income, then an umbrella payment model is likely to come out on top, as shown in Diagram 1.0 below.
This may feel counterintuitive, but it results from the PAYE calculation which will apply to IR35 in the public sector no longer allowing the 5% deduction for general expenses. Also, any Flat Rate VAT benefit will be eroded from 1st April 2017 for labour-only business. As a result, the tax deductions start to level out between PSC and umbrella PAYE.
The key distinguishing factor between PSC and umbrella will be the costs incurred by the contractor. For limited company users, this will include accountancy fees and insurance; whereas for umbrella workers this will just be the umbrella margin which is likely to be lower than accountancy fees. In addition, umbrella working doesn't need the contractor to take on any of the director’s responsibilities currently imposed, such as ensuring accounts and tax returns are submitted on time and the correct amounts of tax are paid -- these are done by the umbrella company.
Diagram 1.0: Take home pay comparison for Limited Company, Umbrella ('SDC’ fail) and Limited Company Deemed Payment (IR35-caught).
Assumptions: The calculations are based on 40 hours per week, claiming £50 expenses and 200 business miles, with a pension of £12 per month, FRV of 16.5% and a director’s fee of £156 per week. All figures include a monthly accountancy fee of £145 for ‘Limited’ and £125 for ‘Deemed,’ or £18.50 p/w Umbrella Margin. Illustration based on day rates of £250, £500 and £750.
Public and private sector contracting
If a contractor works in both the public and private sector, it is expected that they will undertake projects which will be a mix of those caught by IR35 and those which are not caught. In these circumstances, the contractor may wish to keep their PSC open to allow them to continue to trade through it and benefit from drawing dividends on the non-IR35 caught assignments. Getting full value for money on the accountancy/insurance fees and any other expenses will be a key determining factor for all contractors in assessing the value of PSC working. So 2017 will be a good yard stick to assess this value.
That said, the need to continue to properly assess your IR35 status is now more important than ever.
What other factors may influence a limited company contractor's decision to move to an umbrella company?
There are often lots of reasons cited for working through a limited company and the ‘bottom line’ often comes quite low down. Below I have considered some of these other items to see how they compare with working through an umbrella company:
- Limited liability protection -- will be equally covered by the umbrella company so the risk of personal liability exposure is not increased by working with an umbrella company;
- Insurance protection -- reputable umbrella providers will carry adequate insurances for your work and this is usually included as part of the employment package they offer;
- Status -- being an employee of an umbrella company doesn't carry the same status as director of your own business, but this should be weighed against the costs of this status for PSC workers;
- Freedom of choice -- PSC and umbrella working both offer individuals the freedom to choose when and where to work, so there isn't much difference here if flexibility is your driver.
Another item to consider before moving from your own limited company to a PAYE umbrella solution is that while the transition process is likely to be relatively painless, new contracts will be required between the recruitment agency/client and the umbrella company. Beware that some agencies charge for such contract changes mid-assignment.
The switch from limited company to PAYE umbrella can also be made before the limited company is closed as the two relationships are not inter-dependent. Indeed, there may be some instances where putting the limited company into a ‘dormant’ state could be helpful if you subsequently take an assignment which is outside of IR35, or outside the public sector.
As other factors largely balance out, it just leaves us to consider the money!
What are the timescales involved in moving from a PSC to an umbrella company?
If it is decided that some or all future assignments will be operated via umbrella and it is unlikely that a limited company will be needed in the immediate future, then the company should be closed down to avoid fines for failing to run it properly. There is a cost to this in terms of preparing final accounts for the business and filing appropriate forms with Companies House. A period of dormancy is also required (so it won't happen overnight) and I would suggest that you allow yourself a period of 3-4 months to complete this process.
This period of time should give you opportunity to understand if you really don't need your company anymore before closing the business completely and see how the legislation beds in. Notably, how will agencies and end-clients approach the IR35 assessment process (for example, will there be a blanket ban on the use of PSCs or will they take the time to establish the correct IR35 position and make payments appropriately?). When armed with this information, the process to close a company is likely to be easier given the passage of time.
Which umbrella company to choose?
There are many umbrella companies in the market, but are they all equal?
All umbrella companies should all offer similar take-home pay with the only variation being the margin they retain; any that stand out as offering significantly higher take-home pay should be approached with caution.
Beware of offshore providers; providers offering payments by way of loans or other ‘new’ (untested and probably non-compliant) offerings which may spring up. A traditional, compliant umbrella company will offer full employment, make payment via PAYE; provide adequate insurances and, of course, ensure full compliance with the law.
If you use a reputable recruitment agency to find work, they may recommend a Preferred Supplier List (PSL) of umbrella providers to pick from. Typically, but not always, the recruiter will have undertaken due diligence on the umbrellas from a compliance perspective. You could also look to a trade association for a list of compliant umbrella companies, for example the FCSA, which undertake detailed compliance reviews on their accredited members.
Final thoughts
With the IR35 reform changes just around the corner, it is crucial that everyone in the supply chain works together to support the worker’s best interests and to ensure that genuinely self-employed individuals are not unfairly penalised as a result. Public sector end-hirers, recruiters and service companies all play a vital role in ensuring proper IR35 assessments are carried out and that workers are communicated to and have time to prepare well in advance of the changes coming in effect from April 6th.
For individuals working solely in the public sector, the changes coming into play in April could have a significant impact on take-home pay and depending on the end client's and agency's approach to the IR35 assessment process / willingness to engage PSCs at all, contractors will have some decisions to make. Do you only take on private sector assignments? Do you remain in the public sector and consider alternative payment methods?
Whatever your circumstances, it’s always advisable that you chat through your options and the pros and cons of each way of working thoroughly with a trusted adviser who fully understands both ways of working to establish what works best for you personally. One size does not fit all!
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