Catering for the growing band of Freelance Contractors
The following is an abridged version of an article which first appeared in Recruitment International Magazine in October 2005
Fundamental changes to the structure of the global economy in recent years have had a profound effect on the way that businesses and labour markets operate. Freelance, interim and fixed-term assignments have become increasingly prevalent, perhaps fuelled in the UK and
The growing trend towards contracting and freelancing has been accompanied by an inexorable rise in the number of companies that service contractor businesses.
Although a major contractor can operate as a self-employed sole trader, most clients and agents are reluctant to engage them on that basis. If a contractor's tax status is challenged, then it is the client that becomes liable for any additional tax and National Insurance due. The 1998 Income and Corporation Taxes Act (Section 134 ICTA 1988) effectively prevents individuals from being self-employed where an agency is involved, so contractors who rely on agencies to find their clients are obliged to operate through a limited company.
Since the introduction of the IR35 rules in April 2000, which mean that in certain circumstances a freelance contractor may be viewed as a 'disguised employee' by HM customs & Revenue and taxed accordingly, some contractors have become apprehensive about the additional complications and worried about the prospect of a tax investigation. For many contractors, especially those with technical and creative talents, administration and account hold no particular fascination – they want to get on with doing what they are good at.
In this context, it is not surprising that so many ancillary businesses have sprung up in recent years. One such example is the umbrella company, which aims to make life simpler for contractors while maximising their earnings, by taking responsibility for administrative affairs and compliance on behalf of the contractor, and reducing the amount of tax that they pay. Broadly speaking these kinds of organisations come in two guises:
Umbrella Companies, which act as a single limited company for a large number of contractors who operate, notionally at least, within the Pay As You Earn (PAYE) regime.
Composite Companies, in which individual workers own a share of a company that is fully managed by administrators, and receive dividends from their share.
This is something of an oversimplification; in reality, umbrella companies come in all shapes and sizes and can be quite complicated. Some offer a lot of benefits, whilst others offer nothing different from standard temporary employment.
There are a lot of misconceptions about the benefits of umbrella and composite companies. Many agencies believe that working through a composite company will in itself protect the contractor from IR35. This is not true. IR35 status is determined by the contractor’s working relationship with the agency and the client, and the contracts upon which the relationship is based. Therefore, IR35 applies in the same way to composite companies as it does to normal limited companies.
IR35 does not apply to umbrella companies because the contractor is an employee and is paid by PAYE and expenses – not dividends. It may apply to composites, because the worker has shares in the company and is paid by dividends. The advantage of both is lack of administration for the contractor.
Another area of confusion relates to expenses. Umbrella companies may have a “dispensation” from the Revenue which means they do not have to account for certain expenses on P I I D forms. This does not mean that their contractors can claim, for tax purposes, amounts in excess of the expenses actually incurred wholly, necessarily and exclusively for business purposes. They still need to keep their proper receipts, and cannot artificially inflate their expenses in line with dispensation limits.
There is no reason why the umbrella option should not work very well for those contractors who are not keen on running their own limited companies. As a note of caution, they should ensure that their chosen umbrella company is acting within the rules at all times – a good rule of thumb is that if something looks too good to be true, then it probably is. It is also worth bearing in mind that umbrella companies typically charge the contractor between £80 and £120 per month.
Another feature of running a limited company is the requirement to operate a PAYE system and submit regular returns to the Revenue. There are companies that offer standalone payroll services to the contractors and others that offer a comprehensive portfolio of business support services, including invoicing, VAT returns and the production of statutory accounts. Most contractors use the services of an accounts firm, to a lesser or greater extent.
The Professional Contractors Group (PCG), which was originally formed in 1999 to lobby against the introduction of IR35, has since evolved to become the association representing freelance contractors and consultants. As a not-for-profit organisation, it provides contractor members with a range of services and benefits, including tax investigation insurance cover through its own policy, draft contracts, tax and legal helplines, expert guides on IR35 and other tax and freelancing matters, and discounted insurances and other services.
PCG's Affiliate members offer a broad range of complimentary services and products that are relevant to freelance contractors, including accountancy, tax and financial services, banking products and services, business advice and consulting, contract reviews, software, training and development, legal services and the like.
Recruitment agencies are particularly well represented in the Affiliate membership, and PCG works closely with many of them to provide expert advice about IR35 and employment status issues in general. Most freelance contractors do not want to be viewed as employees, and most clients do not want them to claim employment rights, so it is the interest of both parties, and the agency, that the contractual arrangements reflect a contract for services rather than a contract of service or employment contract.
It is probably not an exaggeration to say that many of the businesses providing services to contractors are there by virtue of amendments to company, tax and employment regulations. It will be interesting to see how this evolves with further legislative changes.
