Contractors' Questions: Will a brolly be better than 'Ltd' for public contracts?

Contractor’s Question: What might public sector IT contracting look like after April 2017? Will contractors simply migrate to umbrella companies, given that their limited companies will lose their financial benefits? And how might public sector organisations react?

Expert’s Answer: To answer your question, it’s first important to grasp the fact that the introduction of a new 16.5% category for ‘limited cost traders’ under the flat rate VAT scheme (FRS) will remove the cash advantage for those businesses with limited costs. This new VAT category from April 2017 will catch the majority of PSC contractors who currently ‘sell’ intellectual property. So if you combine the effect of this new VAT rate and the high probability that most contractors will be forced to pay tax as if IR35 applies; most of the benefits of trading through a limited company in the public sector may be lost.

In those circumstances, and if you decide to remain working in the public sector, we foresee many contractors closing their limited companies for the benefits and ease-of-use of an umbrella company. This is all the more likely because many smaller agencies do not operate their own PAYE software, so they may well ‘push’ contractors into umbrella employment. 

We can foresee the public sector favouring the umbrella model as it will place their relationship with contractors outside these costly changes; remove the burden of administration and remove the prospect of financial penalties. But the sector may be in for a surprise, because some currently public PSC contractors will be able to transfer to the private sector; remain outside IR35 and so still gain the tax and other advantages of a PSC, potentially by moving to use the standard VAT scheme.

In closing, it is worth noting before the April rule change that the most misunderstood issue in the contracting market is the treatment of Employer’s National Insurance (E’ers NI). The rate agreed with the public sector body (generally by the agency), is meant to cover all costs including E’ers NI of 13.8%. The agency will either retain the 13.8% themselves (and use it to settle E’ers NI liability if they are paying contractors through agency PAYE), or they will pass it down the supply chain to either the umbrella company or to your PSC. If you are inside IR35 you will have to pay the monies across to HMRC. If your assignment is outside IR35 you will be able to reduce your salary and ‘save’ a large portion of E’ers NI. It is this ‘saving’ that is costing the Treasury £440million a year and is the reason behind the changes.

The expert was Dan Moss, a director at contractor accountants Orange Genie.

Editor’s Note: This is the fourth instalment of a seven-part Contractors’ Questions series based on questions posed in a recent webinar on Autumn Statement 2016 and its impact on contracting. Click to view the previous instalments -- part one, part two and part three.