Your IR35 Status Will Decide How Your Tax Is Calculated
As a contractor, your primary concern is usually how much take-home pay you get paid, but you also need to know your IR35 status and how your tax is calculated. Knowing your IR35 status and using the correct option to be paid as a contractor ensures you should never have any tax issues with HMRC.
With more IR35 changes quickly approaching it is common for contractors to ask themselves, Should I be paid through a limited company or should I use an umbrella company? With new IR35 legislation coming into effect within the private sector from April 6th 2021, the answer to this question is to make sure you are being paid through a compliant umbrella payroll company. Using a compliant umbrella payroll company will ensure you are fully compliant by paying the right amount of tax, so you avoid any tax issues.
IR35 is the UK anti-tax avoidance legislation designed to combat what HMRC saw as tax avoidance by contractors that are regarded as disguised employees and the companies using them. Disguised employees were being paid through their limited companies to possibly avoid paying tax when in practice, they were working as employees for the client company. IR35 determines the employment status of contractors and freelancers, so they are paid using the correct method for a particular assignment.
What Are the Different Options for Being Paid as a Contractor?
- Providing your assignment is confirmed as being outside IR35 you can register as a limited company and handle all your payroll yourself.
- If your assignment is confirmed as inside IR35, you would generally need to use an umbrella payroll company of your choice or one your recruitment agency has verified, with your payroll processed via the PAYE (Pay As You Earn) scheme.
The Limited Company Option
A private limited company or limited company is a privately held small business entity limited by shares or guarantee.
As a contractor turning over a profit, your private limited company will be limited by shares so your limited company:
- Is a legally separate entity from you the business owner.
- Has separate finances from your personal finances.
- Has shares and shareholders.
- Can keep any profits it makes after paying tax.
If you are a contractor with your work assignment genuinely confirmed as outside IR35, then getting paid through your limited company is often the most tax-efficient way of contracting.
Using your private limited company gives you some control over your finances. Invoices are charged from your clients to your limited company, from which you pay tax and get paid a salary. This freedom comes at a price as you will be responsible for your payroll and paperwork. The number of people able to use this option will sharply decrease with IR35 private sector changes in April 2021.
The Umbrella Company Option
If you are a contractor completing an assignment inside IR35, your recruitment agency will offer you the option of being paid through an umbrella payroll company using the PAYE (Pay As You Earn) model. A PAYE umbrella payroll company directly employs contractors and pays them as employees using the PAYE model.
A PAYE umbrella payroll company will:
- Deduct all employment costs and National insurance contributions,
- Provide provision for holiday pay,
- Offer access to a Pension scheme,
- Calculate income tax before you receive your pay.
In essence, an umbrella company sits between you, the recruitment agency, and any end-client, making sure you are paid with all the correct tax deductions meeting the current AWR (Agency Workers Regulations) and IR35 legislation.
Using an umbrella company is the easiest and most comfortable option as they manage all your taxes and payroll, allowing you to save time and money so you can concentrate on your work assignment.
Will the Option I Have to Use Change How My Tax Is Calculated?
If you are a contractor being paid through your private limited company, you will need to consider:
- Corporation tax – This is the tax paid on the annual profits from your private limited company. Corporation tax is usually 19% of your limited company yearly profit.
- Dividend Tax – This is the tax paid on the dividends from your limited company to yourself if you decide to pay yourself with dividends.
- Income Tax – This the tax on the salary income above your personal allowance that you receive from your limited company if you decide to pay yourself a salary.
- NI Contributions (including Employer and Employee NIC’s) - This is the national insurance contribution taken from the salary paid to you from your limited company if you choose to pay yourself a salary. National insurance raises funds for state benefits such as a pension, NHS, and unemployment benefits.
- VAT (Value Added Tax) – This is the tax paid on the sale of goods and services charged at the standard rate of 20%. If your limited company meets the VAT threshold, you must register for VAT and charge VAT on all invoices to agencies and end clients and pay any net VAT to HMRC during your quarterly VAT return.
- Student loan repayments – Repayments taken from your gross income (salary and dividends from your limited company) towards your higher education student loan.
If you are a contractor paid through a compliant PAYE umbrella payroll company, then you will pay:
- Income tax – This is the tax paid on income to individuals based on how much income you are paid above your personal allowance.
- NI Contributions (including Employer and Employee NIC’s) – This is the tax applied to employees and employers every time they are paid which help raise funds for state benefits such as a pension, NHS, and unemployment benefits.
- Apprenticeship Levy – The tax paid by employers to raise funds for apprenticeship training programs.
- Pension Contributions – You have the right to be offered access to a pension scheme where applicable contributions are taken each time you are paid, which goes towards your pension upon retirement.
- Holiday Pay – The umbrella pay rate you are given by your agency includes provision towards your entitled holiday pay. As a contractor using an umbrella payroll company, you will have the option to accrue the holiday pay provision and choose when you receive this or have the holiday pay provision paid on a weekly basis with your regular pay.
- Student loan repayments – Repayments taken from your income towards your higher education student loan.
Do Contractors Pay Tax on Every Type of Income?
As a contractor getting paid during work assignments, you pay tax on:
- The money you earn from employment, i.e. the money you are paid through an umbrella company.
- Profits you make if you are self-employed and paid through your private limited company; this includes earnings from services you sell through websites or apps.
- Some state benefits.
- Most pensions, including state, company, and personal pensions as well as retirement annuities.
- Rental income (unless you are a live-in landlord and get less than the rent a room limit).
- Benefits you get from your job.
- Income from a trust.
- Interest on savings over your savings allowance.
You do not pay tax on:
- The first £1,000 of income from self-employment - this is your trading allowance.
- The first £1,000 of income from property you rent (unless you are using the Rent a Room Scheme).
- Income from tax-exempt accounts, like ISAs (Individual Savings Accounts) and National Savings Certificates.
- Dividends from company shares under your dividends allowance.
- Some state benefits.
- Premium bonds or National Lottery wins.
- Rent you get from a lodger in your house that is below the rent a room limit.
Income Tax Allowances and Reliefs
There are instances where tax reliefs can reduce the amount of tax you pay, but only if you qualify for them.
Tax relief applies to:
- Private Pension contributions when your rate of income tax is 20% or your employer takes workplace pension contributions out of your pay before deducting income tax.
- Charity donations.
- Maintenance payments.
- Time spent working on a ship outside the UK.
- Business expenses when running your own private limited company.
- Money for work-related travel (this does not include travelling to and from work) and things you must buy for your job if an umbrella company employs you.
Umbrella Companies Are the Easiest Option for Contractors
With the new IR35 changes coming April 6th, 2021, the responsibility for determining your IR35 status will rest with your end client or recruitment agency. Using your limited company when your work assignment is inside IR35, could result in HMRC investigating you and possibly ordering you and the end client to pay any incorrectly calculated tax and appropriate penalties. Using an umbrella PAYE scheme avoids all this risk and allows you to have peace of mind while your umbrella company deals with all your payroll admin.
A compliant umbrella payroll company will have the experience, and payroll knowledge to process your payroll and ensure you pay the right tax for your assignment inside IR35. Umbrella companies apply a small margin for their services, but the value of their service is priceless.
Joining an umbrella company is also easy as all you need to do is provide your umbrella company with:
- Right to work documentation, including a copy of your passport if you are a UK resident or residence permit if you are an overseas national.
- Confirmation of National Insurance number including a copy of your p45, P60 or National Insurance card.
- Proof of bank account, including a copy of your bank statement, bank card or online banking account.
- Two different proofs of address including a recent utility bill, council tax bill or mortgage statement.
- Your P45/P60 to ensure your tax code is correct.
- Your next of Kin.
- Your work history for the last three months with your current Recruitment agency or End-user.
- The recruitment agency or end user supplying your work assignment.
- The start date and end date of your assignment.
- Your Job Title.
If you need more information about what documents you need to sign up with an umbrella company, please see our required document guide.
What Type of Tax Deductions Would I Expect to See on an Umbrella Company Payslip?
Umbrella companies deduct all the necessary employment costs and HMRC deductions clearly on your payslip for you to see. Please find the explanations below to the typical tax deductions you can expect to see on a payslip from a PAYE umbrella payroll company.
Employment costs are the costs your umbrella company incurs by employing you, this includes:
- Employers National Insurance
- Apprenticeship Levy
- Holiday Pay
- Employer pension contribution
- Umbrella margin
Gross placement income - The income your umbrella payroll company gets from your agency or end company for the work you have completed.
Effective gross income - This is gross placement income with the above employment costs deducted.
Employee taxes - This is the HMRC income tax deductions and national insurance contributions taken and paid to HMRC before you are paid.
Net Pay – This is your take-home pay, paid to you after all the appropriate income tax and national insurance NIC’s have been deducted.
Please see the reconciliation statement below demonstrating these deductions.
So, What Umbrella Payroll Company Do I Choose?
As a compliant umbrella company Unified Payroll is the right choice for any contractor completing work assignments inside IR35.
Our PAYE umbrella payroll company is fully compliant following HMRC guidelines, IR35 and AWR (Agency Workers Regulations) legislation. We are based in Basildon, Essex, with our PAYE umbrella payroll company providing payroll services for contractors based anywhere within the UK.
Our umbrella payroll company allows contractors to save time and money while we take care of all contractor payroll. Please do not take our word for it, see what contractors have to say about us on Trustpilot and Feefo.
Complete the form below to speak to a member of our team
and get a take-home pay calculation.
Takes 30 seconds