How does IR35 affect umbrella company contractors?

In this guide, we explain what IR35 is, and how it affects umbrella company workers.

What is IR35?

The term ‘IR35’ is used to describe tax legislation created to combat what HMRC call ‘disguised employment’.

This is where an individual works for a client – in the same way as a typical employee – but does so via his or her own limited company.

Historically, you can save tax if you provide services via your own limited company, although the tax benefit has reduced considerably over the past decade.

The original IR35 (2000)

The Intermediaries Legislation came into force in April 2000, via schedule 12 of the Finance Act. It is known as IR35 after the name of the Inland Revenue (now HMRC) press release which first mentioned the proposed new rules.

If you work in exactly the same way as a traditional employee, not a truly ‘self-employed’ person, then the rules may apply to your contract assignment.

Contractors caught by IR35 lose the tax benefits of working via a limited company and all of their contract earnings are subject to normal employment taxes.

The off payroll working rules (2017 and 2021)

Under the original IR35 rules, contractors themselves would self-certify their employment status.

The rules were changed in 2017 for public sector contractors. From this date onwards, end clients would become responsible for deciding if a contractor was inside or outside IR35.

The off payroll rules were expanded to the private sector from April 2021 onwards.

This means that clients are liable for any unpaid taxes if they are subsequently found to have mis-labelled a contractor as ‘outside’ IR35 when he should have been ‘inside’.

As a result of the confusion caused by the off payroll rules, many clients won’t currently hire limited company contractors, and will only use contractors who provide their services via umbrella companies.

Umbrella Companies and IR35

If you work through an umbrella company, you are an employee.

You pay income tax and National Insurance just like any other type of employee.

You’re not providing your services via your own limited company, and therefore IR35 does not apply.

IR35 only applies if you’re providing your services via an intermediary – typically your own limited company.

Not having to concern yourself with this notorious legislation is a key advantage of using an umbrella company.

My umbrella says that it is IR35 compliant – what does this mean?

Umbrella companies are not magical ‘IR35 solutions’, and they are only ‘IR35 compliant’ in the sense that they tax their employees in the standard way.

Some umbrella companies, particularly in the past, have used IR35 in their marketing material to somehow imply that they can offer something extra.

In reality, all umbrella companies have to tax their employees in exactly the same way, and can only compete on the fees they charge to their clients.

Is it worth keeping my limited company open if I take on an umbrella company role?

The IR35 rules apply to individual contract roles. It is possible that you take on an ‘inside IR35’ contract next week, but then work on an ‘outside IR35’ contract in a year’s time.

If you’re already a limited company contractor, it might make sense for you to keep your company running, whilst working through an umbrella company for ‘inside IR35’ work.

Many leading specialist accountancy firms now offer ‘flex’ type arrangements, whereby you can use both their limited company accountancy, and umbrella company operations at the same time.

Alternatively, if you want to keep your company, but work via an umbrella for the forseeable future, you can always make your company dormant.

Only use reputable UK-based PAYE umbrella companies

The use of umbrella companies has risen considerably as a result of the April 2021 IR35 reforms. Mainly as a result of the blanket banning of limited companies by risk averse end-clients.

More than ever, contractors need to take care when choosing an umbrella provider. The industry is unregulated, and there are unethical operators out there.

Only use UK-based PAYE umbrella companies.

Make sure you steer clear of tax avoidance schemes, which may appear to offer amazing (impossible) rates of take hone pay – here are some things to look out for.

Further Resources

Much has been written about IR35 over the past 20+ years since it was first mentioned in a 1999 Inland Revenue press release. To find out more, take a look at these further resources:

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Last updated: 20th April 2023