How do umbrella companies avoid IR35?

How do umbrella companies avoid IR35?

25 June 2020

Umbrella companies allow contractors to achieve IR35 compliance. If a limited company contract is deemed ‘inside IR35’, contracting through an umbrella company is usually preferable.

This will become more important as an upcoming rule change will mean that many more contractors are caught out by IR35 legislation.

From April 2021, medium and large-sized businesses in the private sector will be made responsible for deciding if IR35 rules apply. Currently, this responsibility sits with the contractor themselves.

These changes were due to come into effect on 6 April 2020. This has now been delayed until April 2021 due to the coronavirus pandemic.

‘Inside IR35’ contractors are taxed as if they are employees, but they do not enjoy any of the benefits of traditional employment - such as holiday and sick pay.

How do umbrella companies work?

An umbrella company will tax a contractor as if they are an employee. This means that umbrella contractors pay income tax and National Insurance Contributions on their income, just like employees and ‘inside IR35’ contractors.

However, as an employee of the umbrella company, you will also be entitled to advantages including statutory holiday pay and sick pay, which are not available to limited company contractors.

Using an umbrella company also means that contractors can avoid the bothersome and costly admin that comes with running your own limited company.

Because umbrella contractors are technically employees, they are not subject to IR35 legislation. Accordingly, they cannot be classed as ‘inside IR35’.

Changes to IR35 rules mean that operating through an umbrella company will be more attractive for limited company contractors. In one survey by the Association of Professional Staffing Companies (APSCo), 91% of professional recruitment companies said that they expect umbrella company usage to soar in response to the private sector rule change.

The increase in umbrella company usage is also likely to lead to an increase in the number of illegal, non-compliant schemes. These schemes typically offer very high rates of take-home pay, using illegal vehicles for repayments, but tax authorities will eventually recoup any unpaid tax. 

One of the best ways to make sure you use a compliant umbrella scheme is to look for umbrella companies that are regulated by the FCSA. Umbrella.co.uk is an FCSA accredited member and is one of the largest umbrella companies in the UK.

To learn more about IR35 and using an umbrella company, speak to a member of our team today. Call: 0800 121 6513.