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Occasionally there is more to a Payment answer than meets the eye!
IR35 has expanded the complexity of taxation legislating and forced many more contractors to seek specialist tax advice. Unfortunately, a lot of this advice can be misleading, offering short-term gains with high risks.

HM Revenue & Customs (HMRC) are actively looking into some of the practices used by contractors to minimise their tax payments (tax avoidance) and might well analyse each of your contracts separately rather than take your earnings as a whole. So, as a contractor you need to be very measured when you choose your payment solution.

Pay as You Earn (PAYE)

Avoids the entire IR35 headache and is the HMRC compliant standard. The PAYE system is a method of paying income tax. Your employer deducts tax from your salaries or occupational pension before paying you your salaries. Wages includes sick pay and maternity pay.

This means that you pay tax over the whole year, each time you are paid. Your employer is responsible for sending the tax on to HM Revenue and Customs (HMRC).

Contractors that go through an employment office and receive all income via PAYE
Agencies, only pay a reduced rate as they still have to pay out National Insurance, holiday and sick pay costs, together with the additional administrative burden of running a payroll and complying with current employment legislation.

Personal Service Companies (PSC) / Limited Companies

PSC’s are commonly one man bands, processing income as part salary and dividend payments. In the past, contractors used this method to exploit tax loopholes and improve tax efficiency. Contractors set up a limited company and pay themselves via a minimum wage and dividends.

However, this technique is now classed as risky because:

Contracts inside IR35 dividend payments are simply NOT viable anymore.
HMRC view minimum wage/dividend options as tax avoidance and may impose PAYE.
If there is no “goodwill” in the company, a contractor may be seen as receiving “disproportionate return on initial investment” and dividend will be taxable as PAYE.
(according to section 447 of the ITEPA, 2003)

Outside IR35: if a dividend payment takes a contractor over the 40% tax threshold they will face an end of year tax liability.

You will find many representations and customers will not allow you to use this technique until you’ve had your employment contract reviewed by a IR35 specialist, which can cost upwards of £150 per contract assessed.

Accounting umbrella company

An umbrella company acts as employer to freelance contractors who work under a impermanent contract, usually through an employment agency.

Since the introduction of the Managed Service Company (MSC) legislation in the budget 2007, the only way an independent contractor can comply with this requirement is to set up his or her own personal limited company or use an umbrella company.

An Tax Umbrella company issues invoices to the recruitment agency (or client) and, when payment of the invoice is made, will typically pay the contractor through PAYE (although historically the term has also been used for salary and dividend type payment structures).

Umbrella Companies are fast becoming both the choice for both contractors and agencies alike:

-Company pays the contractor via PAYE on the total contract sum and uses a HMRC approved dispensation to offset business expenses.

-IR35 is irrelevant as all income is paid as PAYE.

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