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Umbrella companies and retaining contractors' funds
Posted Feb 18, 2010
This is part one of a two-part article, kindly provided by Professional Passport.
One recent story relates to a number of contractors whose provider retained monies to meet future tax liabilities, on the understanding that these would be paid on to HMRC once a self assessment return had been completed.
What has emerged is that the company has now ceased and the funds held to meet these liabilities have disappeared; leaving the contractors in a position where they now have to find additional funds to meet these liabilities.
This is not the first time that contractors have lost money held on their behalf by a provider.
How can we identify where these increased risks are present?
The first point to address is that individual taxpayers are responsible for their own tax liabilities. Their personal risk increases dramatically if they entrust a third party to deduct and hold on to these funds on their behalf.
As recent examples have shown, when something goes wrong with a third party (umbrella scheme), the taxpayer is still liable for any backtaxes - not the third party. Contractors in this situation may have to effectively pay tax twice.
The majority of examples in this area relate to self employed or limited liability partnership arrangements offered by providers; some of these arrangements are offshore but this is not always the case.
We suggest that contractors always retain their own monies to meet these liabilities as this is the only way they can control the risk.
The first point to highlight here is that the guidance relates to a compliant umbrella, with appropriate contracts and procedures in place to support overarching employment, as well as all payments made to the worker, over and above those allowable expenses, being paid and taxed fully through the PAYE tax system.
Contractors should be aware that many provider offerings are now described as 'umbrellas'; this cannot be relied upon as a confirmation that they would in fact meet HMRC's definition of an umbrella.
Umbrella providers that fail to meet the requirements of operating a compliant umbrella pose a significantly higher degree of risk to contractors.
With the complex layers of legislation in this area there are some key points to be aware of in relation to non compliant umbrella offerings:
- Non compliant umbrellas could represent a risk to both the contractors and recruitment companies under the MSC legislation and Debt Transfer rules.
- In the case of offshore umbrellas much of the protection afforded to contractors falls away; this can significantly increase the risk of assessed liabilities falling directly back to the contractor.
Compliant umbrellas typically do not hold any significant amounts of contractors' money at any given time; therefore the risks of financial loss are dramatically reduced.
In the majority of cases an umbrella provider makes their payments to their employees as soon as funds are received from the recruitment company; either weekly or monthly. This effectively caps any risk of financial loss to a period between payments, i.e. one week
or one month.
If your umbrella operates a system where they receive monies weekly but run the payroll monthly this can represent a slightly higher risk if issues arise.
Contractors should also ensure their recruitment companies follow our guidance, and that of the many experts; in that all contracts between the recruitment company and an umbrella should contain clauses allowing for immediate termination if the umbrella company enters into liquidation or administration.
This allows a recruitment company and the contractor, to immediately end the contract at the first signs of trouble. The recruitment company and contractor could then move instantly to a new provider and submit any time sheets and invoices for outstanding work through the new provider resulting in little, if any, financial risk or loss to either the recruitment company or the contractor.
Some umbrella providers retain the holiday pay deductions, rather than paying out automatically with each pay run. Whilst this is technically the correct position for an umbrella to adopt, it can present a slight increase in risk if the umbrella provider had problems.
In the majority of cases umbrella providers offer contractors the option of either having holiday pay paid automatically with each pay run or held with a process to request the payments during breaks.
Paying the holiday pay automatically does not represent any increased risk to the umbrella; where the holiday pay is correctly highlighted through the payslips. This area relates to employment laws and therefore is not typically considered by HMRC on any compliance visit.
Where contractors are risk adverse they should request the payment of holiday pay automatically with each pay run.
In most instances an umbrella operating the typical compliant model represents a low risk to a contractor as few funds are held and contracts can be immediately terminated.
You can also read part two of this article - the main financial risks faced by umbrella companies.