Contractors’ Questions: Which umbrella payment model is under attack?

Contractor’s Question: What exactly is the expenses payment arrangement and tax administering that umbrella companies have been warned against by HM Revenue & Customs when paying contractors? And what might an acceptable payment arrangement for expenses, including the associated taxes, look like?

Expert’s Answer: The method HMRC are attacking, known as ‘pay day by pay day’ and broadly where an employee incurs travel expenses out of gross salary, is as follows:

The employee – the contractor in the umbrella company – receives a gross salary and they personally incur the cost of travel expenses out of their salary with no payment or reimbursement by the employer.

The umbrella company processes, on a monthly basis, the tax relief for payments in relation to travel expenses incurred by employees, for which the employee/contractor is entitled to claim a tax deduction, and deduce this from their gross salary.

In HMRC’s opinion, tax relief should be obtained by the individual claiming a deduction through their self assessment tax return at the end of the tax year (so not monthly), by the individual making the appropriate claim.

So in effect, the employee/contractor needs to wait until the end of the tax year to make the claim and, HMRC say, the relief cannot be brought forward by the employer. Additionally, HMRC state there is no relief on National Insurance when using this method.

In terms of other methods for making payments of expenses, they include:

Payment/Reimbursement of travel expenses are in addition to Gross Salary, with a valid dispensation

Under this system, the umbrella contractor/ employee receives a monthly gross salary plus an additional payment/reimbursement for expenses. 

Where the employer holds a valid dispensation for business expense payments, the additional payment in respect of the dispensation expenses can be paid to the employee without the deduction of PAYE or NIC. 

The tax relief for the payments under this model is given at the time the payment is made.

Payment/Reimbursement of travel expenses in addition to Gross Salary, with no valid dispensation

Under this system, the umbrella contractor/ employee receives a monthly gross salary plus an additional payment/reimbursement for expenses. 

Where the employer does not hold a valid dispensation for business travel expense payments, the additional payment must be processed with appropriate income tax deducted under PAYE ( with a claim being made at the end of the year by the employee on their self assessment return to obtain the tax deduction). Depending on the payment there may be no NIC deduction on this amount.

The expert was Paul Spindler, a partner in the technology group at chartered accountancy firm Kingston Smith.

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