One of the most potent motivators for humans is money. It has sparked fights, torn families apart, pushed ordinary people to extraordinary actions, and even pushed extraordinary people to desperate conclusions.
This was the situation of contracting in the United Kingdom at one point. Contracting companies used legal loopholes to lower their tax payments and increase their profit margins across the board. As firms reduced their own culpability, they unwittingly increased that of their employees, making it a matter of chance and time before they were discovered by the system.
PSC’s (Personal Service Companies)
PSC’s or Limited Companies have always been the most appealing alternative. When a contractor registers for a Limited Company, he or she becomes a company director. This provides him complete control over how the company’s money is spent, as well as the ability to file a variety of valid tax claims. Ltd companies usually report contract income as business income to take advantage of the NI-free dividend payments that were previously solely available to the company’s owners.
PSC’s are, in fact, more tax efficient than umbrella companies, but they require significantly more legal documentation. IR35, which mandated the construction of umbrella companies, was enacted as a result of this wide spread and continuous concealment of job income.
IR35 was established.
The IR35 is a tax law that was put in place in 1999 to allow the government to tax “disguised employees” appropriately. Contractors that utilise an intermediary firm to “receive” payment from their clients without a direct transfer of money are referred to as “disguised employees.”
Contractors’ income would be tax-free because they paid themselves through the companies they owned. This is due to the fact that the company’s profit, not its income, was subject to as much taxation at the time.
The HMRC (Her Majesty’s Revenue and Customs) and treasuries eventually recognised they had been duped, and IR35 was born.
Contractors found it difficult to receive the same tax benefits as a regular small business once the IR35 legislation was enacted. The government would conduct “tests” to see if contractors were qualified.
Umbrella firms arose as a result. These businesses would hire contractors on their behalf through recruitment firms. This arrangement allowed contractors to use umbrella companies as their “home” offices, allowing them to claim travel expenses, overnight expenses, and other expenses from the office to their clients’ locations, as long as they were not directly supervised, directed, or controlled by their end client.
Another result of IR35 is the formation of this type of business. It creates a Limited Company with 5 to 8 independent contractors as shareholders. The standard strategy is for these contractors to be paid the least amount of money feasible while getting the rest as dividends.
This method was prevalent until 2008, when new legislation was enacted that directly challenged the usage of Managed Service Companies to avoid paying taxes.
Currently, the Situation
PAYE umbrella firms are still the best option to contract in the UK right now. Limited liability corporations (LLCs) are ranked second because they provide for certain tax exemptions. With the new law putting the burden of determining “IR35” employment status on public sector employers, limited businesses will play a smaller role in the contracting market in the future. However, some businesses may be concealing one of the strategies.