Umbrella Companies And Tax Avoidance
Navigating the intricate landscape of UK tax legislation is no easy feat, especially for contractors. Amidst the myriad of regulations, one term stands out prominently: Umbrella Companies. But what is umbrella company tax avoidance?
In this comprehensive guide, we delve deep into the heart of umbrella companies. Whether you’re an aspiring contractor or a seasoned veteran seeking clarity, this guide aims to empower you with the knowledge to make informed decisions and remain compliant.
Umbrella Company Tax Avoidance
A tax avoidance scheme operates with the intention of bending the rules of the tax system to gain an advantage that was never intended. They often involve contrived, artificial transactions that serve little or no purpose other than to produce this advantage.
When it comes down to it, most tax avoidance schemes do not work, and those who use them may have to pay much more than the tax they tried to avoid, including penalties.
In recent years, various tax avoidance vehicles masquerading as umbrella schemes have targeted contractors and other workers, offering inflated take-home pay rates. The warning signs may be obvious to established contractors, but many have been duped into using them.
How Tax Avoidance Schemes Work
Tax avoidance arrangements, also known as disguised remuneration schemes, involve an umbrella company giving you some or all your pay in the form of a loan, salary advance, grant, annuity or any other payment you’re told you’re not expected to pay back. These payments are claimed to be non-taxable, often without explanation, and can lead to higher take-home pay.
You may be asked to sign an agreement with an umbrella company in addition to your employment contract. This will often be a loan or other arrangement that attempts to disguise some of the payments paid to you by your umbrella company as non-taxable.
The untaxed amount may be diverted through a chain of companies, trusts or partnerships (often based offshore) and paid to you by a third party. In other cases, the payments may be made directly to you from a UK-based umbrella company.
It is worth noting that some tax avoidance schemes market themselves as being compliant umbrella companies. Compliant umbrella companies only operate via PAYE and never advertise or promote tax avoidance arrangements.
How to Spot a Tax Avoidance Scheme
Here are some warning signs that you might be in a tax avoidance scheme or are being offered to join one.
i) Higher Take Home Pay
A contractor who operates through a legitimate and compliant umbrella company can expect to retain 60-70% of their salary after the relevant tax and National Insurance Contributions (NICs) have been made.
If a company claims you can retain up to 80% or 90% of your salary, it is most likely a tax avoidance scheme. Remember that the basic income tax rate is 20%, and you must also pay national insurance contributions.
ii) Unusual Payment Arrangements
Some schemes designed for contractors involve giving workers some or all of their payment either as a loan or other payment they’re not expected to repay. These schemes, promising to put tax-free income into a contractor’s pocket, do not follow HMRC’s prescribed rules.
iii) Multiple Contracts
Your umbrella company may ask you to sign another type of contract or agreement in addition to your employment contract. If they do, this can be a sign of a tax avoidance scheme.
iv) Misleading Claims
The scheme is advertised using misleading claims suggesting they are endorsed or approved by HMRC. These include: ‘HMRC approved’, ‘Retain more of your earnings after tax’, ‘We ensure you get the highest take-home pay’ or ‘Compliant tax efficient pay’.
HMRC does not approve or endorse private limited companies.
v) Based Outside UK
Most tax avoidance schemes are located outside of the UK in well-known tax havens, including the Isle of Man, the Channel Islands, the Cayman Islands, East Asia, and South America.
If you are a UK taxpayer, assuming your payroll provider should also be UK-based is sensible. An offshore address is a significant warning sign.
HMRC maintains a list of tax avoidance schemes, although they note that it is incomplete. If an umbrella company isn’t on the list, it doesn’t automatically make it safe to use. Contractors should always do their due diligence.
Tax Avoidance Scheme Penalties
Tax avoidance arrangements that claim you pay less tax are incredibly high risk. Most of these schemes do not work and have been successfully challenged by HMRC in the courts. If you’re involved in a tax avoidance scheme, HMRC will thoroughly investigate your tax affairs and may also require you to pay the tax you’re trying to avoid upfront.
You may receive a tax bill called an accelerated payment notice, a requirement to pay the total amount of tax or National Insurance contributions HMRC calculates as being due upfront and within 90 days.
If you do not pay the tax and National Insurance contributions you owe, HMRC may decide to take legal action and take you to court. HMRC states that they win around 9 out of 10 avoidance cases heard in court. If you lose, you could face significant legal costs on top of the tax you owe, penalties and growing interest.
Finally, HMRC will treat you as a high-risk taxpayer. They will closely inspect all your tax affairs in future.
How To Proceed
HMRC offer an interactive risk checker to help contractors working through umbrella companies identify if their employment arrangements could involve tax avoidance. If you’re still unsure, you should seek independent professional advice.
If you think you’re in a tax avoidance scheme, don’t wait for an investigation to catch you out. You should withdraw from the arrangement and settle your tax affairs with HMRC. The longer you put off settling and paying the tax due, the more interest you’ll pay, and the more you risk court proceedings.
HMRC has dedicated teams who can help you settle your affairs and won’t charge you for their advice.