What Are IR35 Avoidance Schemes?
Understanding IR35 Avoidance Schemes and How to Identify Them
As reforms to IR35 in the private sector draw closer, a number of contractors are finding themselves classified as ‘inside’ IR35 and in need of a new employment solution. As a result, many Umbrella companies are popping up with tempting offers for contractors who are missing their ‘outside’ income. These Umbrellas are promising reduced tax rates and increased take-home pay. And, unfortunately, many contractors are lured in by these IR35 tax avoidance schemes disguised as ‘tax-efficient’ offers.
The increase in non-compliant Umbrellas is concerning for employment agencies because although you may not be part of the scheme yourself, you could be held liable for partnering with an Umbrella company who is operating one – even if you’re unaware of it. According to HMRC, if one party in the supply chain is not compliant, it’s the other parties’ responsibility to do their due diligence, otherwise, they too could be found liable under the Criminal Finances Act.
What is an IR35 avoidance scheme?
In it’s simplest terms, an IR35 avoidance scheme is any scheme that helps the supply chain or contractor to avoid paying tax.
This can present itself in two ways:
- Rarely, contractors manipulate how they pay themselves through their PSC so that IR35 doesn’t apply to them. For example, a contractor may set up their business and register it overseas, to avoid the UK’s tax laws.
- More often, and more concerning, are disguised remuneration schemes. These are led by employment agencies and Umbrella companies or other providers who entice contractors with claims of ‘legitimate’ or ‘tax-efficient’ methods of keeping more of their income by reducing tax liability.
How does disguised remuneration work?
These schemes work in different ways, and some may be more easily identifiable than others. Occasionally, a company will ask contractors to sign up to an ‘arrangement’ of this kind. However, most companies’ schemes won’t be this obvious, so it’s important that your agency only partners with compliant companies who are paying contractors legitimately.
The usual way payments are made through disguised remuneration schemes is:
- The contractor receives a small amount of their monthly payment as income via the Umbrella/agency’s normal payroll. This will often be just enough to take the contractor’s salary over the tax-paying threshold (currently £12,500 per annum). The company will deduct the necessary tax and National Insurance contributions from this minimum payment.
- At the same time, or shortly after, the contractor will receive a larger payment (the remainder of their monthly salary) without tax or National Insurance deducted. This will be presented on their payslip as a ‘loan’, ‘capital contribution’, ‘bonus’, ‘credit’ or something similar.
- The Umbrella company or employment agency is also likely to deduct a charge, which is often significant, for ‘professional fees’, ‘admin fees’ or something similar. They will keep this money for themselves as payment for managing a contractor’s payroll.
This kind of disguised remuneration scheme is beneficial for the companies running them because they can pay ‘inside’ contractors less than they should, but the contractors still receive the same take-home pay (or more) because they’re not paying the correct tax.
However, HMRC is vigilant about tax avoidance schemes, especially in the lead up to the IR35 reforms. There are various ways HMRC can identify businesses that are payrolling large numbers of contractors just over the payroll tax allowance, and therefore might be operating such a scheme. And when these companies are found, they will be liable for any unpaid tax.
Unfortunately, in many cases, by the time HMRC has identified the non-compliant company, they have disappeared, leaving the contractor, your agency, or any other agencies in the chain potentially liable for partnering with a company who is participating in a tax avoidance scheme.
How to identify tax avoidance schemes
As your agency may be held liable for working with one of these companies, even if you’re blindsided by their scheme, you must know how to identify them.
When deciding on your preferred suppliers’ list, you can check a variety of things about a company’s payroll management to determine whether it’s participating in IR35 avoidance schemes:
- Before you begin working with a company, look into their jargon. More often than not, avoidance schemes will be dressed up with phrases about ‘legal opinions’ and ‘tax efficiency’ instead of an emphasis on compliance.
- Similarly, if the company promises contractors can keep 80, 90, or 95% of their wages, they’re most likely operating under a scheme. Usually, the basic rate of Income Tax is 20% plus National Insurance contributions. So 80% take-home pay for more than a week or two is almost impossible.
- If you begin working with a company and you find that only a fraction of a contractor’s salary is paid through payroll and subject to PAYE, this indicates only a portion of the contractor’s income is being taxed, disobeying UK tax laws.
- If contractors are paid using a ‘loan’, ‘credit’, or ‘investment’ payment which isn’t subject to income tax or National Insurance, this is a strong sign of a tax avoidance scheme.
- If a contractor’s payment is routed through various companies before reaching them, instead of being paid directly to the contractor, this is a sign of a tax avoidance scheme.
How we can help
It’s your agency’s responsibility to ensure you’re only working with compliant payroll suppliers and Umbrella companies. If you recommend unlawful suppliers to your end hirers or contractors, not only are you at risk of financial penalties and disrepute, but your end hirers and contractors are exposed too.
To avoid this, JSA offers a compliant, FCSA-accredited Umbrella company, giving you peace of mind your contractors are being paid how they should be.