All Posts by Greg Dickson

A Flat Rate VAT Guide for Contractors For 2018

It is no secret that the 2016 Autumn Statement carried on the ‘noose tightening’ that the contracting sector has felt in recent times. Contractors have long since realised that HMRC was gunning for them and the last couple of years have confirmed that as the May / Hammond double act have made it clear that they are keen on all limited company contractors, self-employed individuals and regular employees being in the same boat when it comes to tax and national insurance. In other words, this government and HMRC are fully intent, it would seem, on removing all perks for contractors working via limited companies over the next few years. They have proven this with the ever-stricter IR35 legislation and a crack down on expenses over the last decade.

First, They Increased National Insurance

Last year they announced an increase in national insurance for contractors. HMRC and the Treasury are trying to decrease the gap between regular salaries and the combination of salary and dividends. Their first move was to raise type 4 national insurance up to 11% from its previous rate of 9%. They also, incidentally, decreased the dividend allowance from £5000 to £2000. And most commentators believe they will keep going further, taking small steps towards that parity between the self-employed and those in regular employment.

Then They Went For VAT

The Autumn Statement of 2016 brought a completely new change by Philip Hammond, a new category of flat rate VAT, which threatened to raise the VAT bill for a regular contractor limited company up to 16.5% (from 14.5%). How does this work? Below we will look at the figures and how they will affect most contractors.

The Limited Cost Contractor

The changes to the VAT system have brought the idea of a new, all-inclusive category – the ‘limited cost trader.’ The definition of a limited cost trader is someone whose (VAT inclusive) expenditure on any goods will be either (a) less than 2% of their (VAT inclusive) turnover or (b) less than £1000 per annum in total.

The problem here though, and what is annoying for anyone who runs a service-oriented business, is that the concept of ‘goods’ does not include capital expenditure (such as the purchase of assets), drink or food, fuel or vehicles. But worst of all, the purchase of services is also excluded. So, even if you run a minor consultancy firm and have no chance of being caught in the IR35 net, you will still be penalised unfairly. Anyone who runs a service based company will know that there are all kinds of significant outgoings. These might include legal fees, accountancy fees, phone and email, website hosting, journal subscriptions and industry memberships and insurances for example. Yet with all of these (and many more) outgoings, it would still not be possible to escape being categorised as the aforementioned ‘limited cost trader.’

So What Happens Next?

From April 2017, as small service limited company owners, service-oriented contractors will have the simple FRS VAT system (Flat Rate Scheme) like other business owners, but they will be required to pay more for that same privilege. This is crazy when you think that approximately 78% of the UK’s GDP comes from service-oriented businesses!

Wow! What Will It End Up Costing Me If I’m A ‘Limited Cost Trader?’

It will be a significant change, that’s for sure. If you have a service business and you charge your clients £350 per day then after the Flat Rate Scheme changes you will end up more than £2000 per annum worse off if you are on the scheme. If your day rate is £150 you would be £864 worse off, if you charge £250 you would be £1440 worse off and so on. Consequently, if you would be classed as a limited cost trader and know that being on the FRS would raise your VAT bill, then you should give some thought to changing to the regular VAT scheme.

FRS or Standard Scheme?

Whilst the FRS will simplify your VAT and you will only pay a percentage of gross turnover, the standard scheme sees you needing to both add the VAT charged to clients as well as deducting the VAT paid on both the goods and services you have paid for. That difference is then owed to HMRC. That might sound overly complicated but with most companies and individuals having access to online accounting apps which can do this in a second, there really is no complication. So it is just as easy to be on the standard scheme as on the FRS.

Ok, So Should I Quit the FRS?

It’s actually quite an easy calculation to decide if you should remain in the Flat Rate Scheme or quit it. Ask yourself one simple question – do you spend in excess of 1% of your yearly turnover on goods and services that are subject to VAT? If you do, then you would likely be better off changing over to the standard VAT scheme.

In reality, it will probably all depend on the kind of business you operate. Should you be the type of contractor who skirts the edges of IR35 and who has very few outgoings except for travel and subsistence then you are exactly the kind of contractor that the Chancellor is after. You will take a big hit on the FRS rate rise and similarly would not be any better off changing to the standard VAT scheme.

However, should you be the type of contractor who operates a service business in the form of a consultancy style company then you will actually probably do better if you change over to the standard VAT option.

How Do I Leave the Flat Rate Scheme?

That part is actually quite simple. All you need to do is talk to your accountant and ask them to write to HMRC on your behalf, requesting the change. That’s it!

In Conclusion…

Once again, all this seems to be deeply unfair to contractors and the contracting sector has more reason to grumble about their treatment at the hands of Chancellor Hammond. He might have done it all because of what he saw as ‘aggressive abuse of the VAT Flat Rate Scheme’, but in reality, this, like many recent measures seems overly punitive and will likely affect the competitiveness of service businesses, particularly with the timing placing it alongside everything going on with Brexit.  Throw in the ever tightening of IR35 and the changes to national insurance and it is becoming clear that contractors should give serious thought to becoming consultants, especially if they don’t wish to continually be the target of HMRC come budget time!

Limited Company Salary and Dividends

In the eternal debate on the best way for contractors to pay themselves, limited company contractors can still maximise their earnings (post tax) by paying a lower salary to themselves and then taking the balance of their pay via dividends from the profits of their company. There was some doubt as to whether this would remain the case after the tax hike on dividends that was adopted in April 2016, but it is still the most tax effective, mainly because those dividends are still not subject to NIC’s (National Insurance Contributions.) In addition to this, when the spouses of contractors have become shareholders in the contractor’s limited company, the contractor is also able to make full use of that spouse’s tax allowance. This can be done by both splitting the basic salary as well as splitting their limited companies dividend income so that they can reduce their combined tax liabilities even further and then maximise their net income.   

Ok, How Do Contractors Pay Taxes Then?

Contractor salaries work in a similar way to most people’s salaries. If the salary that the contractor pays themselves is over their personal allowance (which in 2016/17 was set at £11,000) then the part that is over their personal allowance is classed as taxable income and it will have income tax rates applied to it. (Not everyone will have a personal allowance of £11,000 as it will vary according to the tax code their tax profile has been assigned.) After that, their first £32,000 of that taxable income will then be subject to 20% basic rate income tax. And once the taxable income goes over the £32,000 limit, then a higher rate of 40% is applied in tax, all the way to £150,000. And finally, any income that goes over the £150,000 cap is taxed at a rate of 45%.

How Are Contractor NIC’s Calculated?

As well as this, employees (and we include limited company contractors in this category because they are classed as employees of their own limited companies) will have to pay HMRC an additional 12% of their gross earnings in NIC’s (National Insurance Contributions.) This 12% is paid on any earnings over £155 (per week) all the way up to a weekly rate of £827. At anything over £827, the NIC’s rate will drop down to just 2%.

With all these different tax rates and National Insurance contributions, it is easy to see why contractors have for a long time kept their salaries low!

What Are Employer’s National Insurance Contributions?

However, there are more taxes to consider. The limited company of the contractor must additionally pay employer’s national insurance contributions at a rate pf 13.8% on the amount of their contractor’s earnings which has been taken as salary and which is in excess of £156 (per week.) This is paid by the employer, which in the case of a limited company contractor is the limited company. This is another reason why contractors keep their salaries at low rates – not only do they minimise their employee’s contributions but it also helps minimise their employer’s contributions too!

What Happens If A Contractor’s Annual Income Goes Above £100,000?

Finally, there is one additional stealthy tax to weigh up. If a contractor’s annual income goes over £100,000 then their personal allowance decreases. This is calculated as follows – each £2 that the contractor earns over the £100,000 limit will see their personal allowance reduced by £1. So, if a contractor earns more than £122,000 then that personal allowance will be reduced down to nothing. This is bad enough but for every £2 that they earn from £100,000 to £122,000 they will be paying the aforementioned rate of 40% and then an additional pound is also being taxed at 40% now as they lose that allowance. In the end, this means they are being hit for an effective tax rate of 60%!

Ok, Then What About Dividends? How Are Dividends Taxed?

Dividends are the way that companies are able to distribute their profits out to their shareholders. Provided that the company is profiting, it is allowed to declare dividends at any time of year. Any attempt to declare a dividend if it is not in profit is defined as an illegal dividend, and problems will follow. How can a limited company make sure it doesn’t do this? By calculating its profits correctly – this is done by simply deducting any of the business outgoings  (including salaries and accountancy or insurance bills for example) from the total fee income. Thereafter, the company must deduct corporation tax at 20% out of the profits. Once this has been done the balance left can then be distributed as dividends to the shareholders of the company (which in the case of contractors will be the contractor themselves and also sometimes the spouse of the contractor.)

In addition to this, there is also a tax-free £5000 dividend allowance. It is not an allowance in the traditional sense of the word when it comes to tax. Instead, it is a zero rate band which comes out of the usual income tax bands (£32,000, £150,000 etc) mentioned above.

As an example, imagine that a contractor’s personal allowance has been fully used on a gross salary of £11,000 whilst the rest of his / her salary is taken out in dividends. The next tax band for the contractor will be at the basic rate up to £32,000. In this band, dividends will be taxed at a rate of 7.5%. However, within that band, the first £5000 will not be taxed at all, thanks to that £5000 dividend allowance. This means that in effect only £27,000 of the total £32,000 will actually be taxed at a rate of 7.5%. And after that, income from dividends that comes in the higher rate band (between £32,000 and £150,000) will be at a much higher rate of 32.5%. Similarly, any dividends that come in the band above £150,000 will be hit at a rate of 38.1%. However, dividends, in general, do not attract any employer national insurance contributions.

Salary and Dividends – A Comparison.

At a most basic example, any contractor who takes the minimum salary of £8000 and then takes the rest in dividends will easily pay a lot less national insurance and tax than contractors who are paying themselves simply through a salary, simply because the NIC’s have been minimised.

Within the limited company, once the corporation tax has been paid at 20% on gross profits, a contractor who was taking out dividends would only be required to pay an additional 7.5% on their first £27,000 worth of divided earnings falling within that basic rate cap, taking into account the dividend allowance. This would work out to be £2025. Therefore it quickly becomes obvious that it is advantageous to go down the lower salary and dividends road in order to get the most income and pay the least tax.

How To Use Your Personal Allowance and Your Split Dividends

As discussed above, any contractor who shares his or her limited company ownership with their spouse or partner will be able to benefit from their spouse’s tax allowances (if that spouse has no other income) through ‘income splitting.’ The contractor can assign 50% of their shares to the spouse whilst keeping 50% themselves. The dividends would then be paid out with both the contractor and the spouse getting 50% each.

What this means is that because the personal allowance and dividend allowance of the spouse are there to be used, contractors can in effect have twice the allowances. Post-corporation tax, contractors and spouses could take something like £10,000 of dividend allowances with their limited company in addition to their personal allowances without having to pay extra in NIC’s or tax, simply by going for the dividends and lower salary option. After that, they could go on and take out an additional £27,000 each while still on that basic 7.5% rate. 

Lastly, What About Settlements Legislation and IR35?

Of course, if there is a way for people to reduce their tax burden there is also probably a way for HMRC to try and stop them doing so! Thus did sharing company ownership and company dividends briefly become a controversial issue. HMRC tried to tackle this income splitting by going back to the settlements legislation in which income earned by the spouse of the contractor would be treated as if it were the income of the contractor and would be taxed similarly. This attempt was thwarted, however, when HMRC lost the test case, known as the Arctic Systems case. HMRC went on to draft some legislation to tackle income splitting but never brought it to law.

On the other hand, IR35 legislation was introduced in 2000 and has been on the books ever since. This legislation, designed to tackle disguised employment has been the bane of contractors ever since and has been getting stricter and stricter. It is the most important legislation for limited company contractors to get their heads around and anyone assessing the merits of different ways of working for tax purposes should also spend time assessing whether they might be within IR35.

Why Contractors Need Professional Indemnity Insurance

So you’ve done it, made the leap and go it alone. As a contractor, you are now master of your own destiny and manager of your own business. But with that freedom comes the need to protect your business and make sure it can cope when times are tough. When you were working for a large company as a permanent employee that company gave you protection. As a contractor, you need to protect yourself – from all of the mishaps and accidents, unforeseen incidents and unlucky breaks that come as part and parcel of running any business. For this reason, all working contractors need to be certain they have put the right insurance policies in place and that they keep them up to date throughout their career. This includes the three main general insurances – public liability insurance, professional indemnity insurance and employers insurance – and any smaller policies that are applicable to your particular contracting industry. In this article, we will take a look at arguably the most important of these policies, professional indemnity insurance.

What Exactly Is Professional Indemnity Insurance for Contractors?

Professional indemnity insurance is perhaps one of the most important types of insurance that new contractors should be considered when choosing what cover to arrange. Often called PI insurance, professional indemnity is crucial for any contractors who offer services or provide advice to businesses and people in a professional capacity, as it covers their expenses and legal costs if someone makes a claim that their advice has been inadequate or their services have led to clients losing money. All professional indemnity policies will provide some kind of cover against claims for the following – negligence, breach of confidence, intellectual property infringement and defamation. A lot of policies will also provide this cover retroactively, meaning if you take it up after you have been contracting for a while it will still cover all the work you have already done.

Who Should Get Professional Indemnity Insurance for Contractors Then?

All contractors, freelancers and consultants should seriously think about getting it, but it is an absolute must for those self-employed workers whose job it is to provide ideas, services, advice or designs for their clients. If there is even the slightest chance of you giving someone bad advice or services (or even of being accused of giving bad advice or services) then it is essential to get yourself covered. Professional Indemnity insurance will stop you having to worry about frivolous (or real) claims and protect you if you need to raise legal costs or even pay out settlements. Contractors in the following industries should certainly be getting professional indemnity: Business and management consultants, Training and HR consultants, accountants, IT professionals (including developers, designers, programmers and consultants,) marketing and media consultants.

Is Professional Indemnity Insurance for Contractors Mandatory?

Not legally, no. But there are certain professions in which contractors are required to have professional indemnity insurance as part of their professional certification. These include law, surveying, town planning, accounting and architecture amongst others. Each of their professional bodies insists on at least a basic level of professional indemnity insurance to protect both the client and the contractor/freelancer.

How Much Does Professional Indemnity Insurance Cost?

Generally cover for professional indemnity will cost contractors roughly between £6 and £10 a month. It is worth shopping around though and comparing policies (with a list of all the features you are looking for) online before phoning and speaking to anyone.

Is Professional Indemnity Insurance Advantageous for Your Contracting Business?

Yes, absolutely. You will find that many contracts you are competing for will include a clause that the clients will only work with contractors who have this indemnity insurance in place. Having professional indemnity insurance will both provide an extra layer of appeal to your contracting business and stop you losing out on contracts where it is a requirement.

Do I Still Have to Get Professional Indemnity Insurance if I Have Public Liability Insurance?

Yes. Both are necessary because they do very different things. Public liability insurance will cover you for any claims that are made against you for injuries, accidents or illnesses (or damage to property) whereas as discussed above, professional indemnity insurance will cover you for advice, ideas or designs. Thankfully, most insurance companies will offer you a good deal on getting the two of them together in one package.

How Do I Work Out What Sort of Level of Insurance I Will Need?

Clearly, this will be dependent on the industry you contract within but generally, most contractors arrange cover for public liability at £1 million and for professional indemnity insurance at £10 million. You may also have to adjust this amount if you work for an agency or client who specifies a higher level of insurance is required.

Contractor Public Liability Insurance

You’ve just left your old company and gone it alone. Finally, you are free and in charge of your own business – and that business is you. But before you start building that business you need to make sure that the foundations are solid and protect it against any rainy days that might turn up unexpectedly at some point in the future. When you worked as a permanent employee for a large firm you would have had all those protections built into your employment – sick pay, maternity pay, pensions etc. And if anyone decided to sue the company, it would not have affected you personally. As a contractor, things are different. You are responsible for your own admin, your own tax, pension and sick cover and most importantly, your own insurance to cover yourself when things go wrong. And this is why one of the first things any new contractor should do is make sure he or she has the right insurance in place. Which insurance should you get? There are three main types of insurance that all contractors need to look into – employers liability insurance, professional indemnity insurance and public liability insurance. In this article, we will explore public liability insurance.

What Exactly Is Public Liability Insurance For Contractors?

Public liability insurance is a type of insurance that covers you and your company for a wide range of scenarios in which someone, or something, becomes injured or gets damaged because of you or your business and you are then held responsible. If your business interacts with the public (including other businesses and clients) in any way (which of course it will) then you need to seriously think about purchasing public liability cover. If you visit clients at their place of business or if you have clients come to your office or to your home office then you will need it. You might have clients come and visit you who trip over some storage boxes you have lying around and get injured. Or you might do some work at their premises and break some of their equipment accidentally. In both cases, public liability will have you covered. This applies to contractors across all fields. Say you are an IT contractor who installs software on site for clients. You might drop your coffee on one of their computers and cause some serious damage. Or you could be a website designer who works from a small office and you invite a client to come to the office and the same thing happens. In these and hundreds of other scenarios, public liability insurance will have you covered.

Is it Mandatory? Do I Really Need Public Liability Insurance?

Of the three insurance types mentioned above, only Employers Liability Insurance is legally required (if you have more than one employee.) But that’s not to say you shouldn’t still view it as essential. Indeed, many professional bodies (such as in law, accountancy or architecture) will insist you have it before issuing you with their accreditation. And you will very quickly find that every major client who you want to work with will probably have a clause in their contract that insists you are covered by both professional liability insurance and public liability insurance. Additionally, even if all your clients don’t insist on it, it just looks more professional to have it. And the most important reason of all? This is your business and your livelihood. You might never put a foot wrong but you can’t control other people. If someone claims against you, either with good reason or frivolously, it could end up costing so much as to put you out of business and in debt. Why not pay a small amount just to have that peace of mind that you are covered? And one final point – if your business does grow and you take on staff, you will need public liability insurance to cover their actions too, in case they cause someone to sue your company.

Are There Any Advantages To Getting Public Liability Insurance For Contractors?

There sure are. As mentioned above, you will inevitably come across contracts that have a clause requiring you to be covered adequately by insurance. Having it already in place means you will never miss out on contracts and will add that extra sheen of professionalism to your business.

Do I Need Both Public Liability Insurance and Professional Indemnity Insurance?

Yup. Both do different things and both are equally important. Professional Indemnity insurance covers you against claims made relating to advice you gave or a service you provided whereas public liability is all about injury to the person or to property. However, most insurance companies offer very good combined rates to contractors signing up to both types of insurance in one package.

What Amount of Insurance Should I Get?

This depends on a number of factors such as the industry you work in, the type of work you do and the requirements of the agencies or clients you work for but as a rule the basic contractor cover sits at around £10 million for professional indemnity insurance and £1 million for public liability.

What Should I Look At When Comparing Providers?

Firstly, that they offer the base level of cover that was just discussed but preferably that they can offer more than that – either £5 or £10 million for public liability. And secondly that they can do a deal and bundle the two (or three) main insurance types together for a decent price compared to buying them as stand alone products.

Income Protection Insurance for Contractors

Contractors need to think about covering themselves with insurance more than most other workers as they have left behind the security and perks of permanent employment for larger companies. The cover that comes with that permanent employment package should not be underestimated, which is why it is essential from the outset that contractors get all their insurance sorted out. Most contractors will rightly invest in the big three insurance types, public liability, professional indemnity and employer’s liability insurance. However, because contractors do not get sick pay and sick leave like workers employed by companies, there is another type of insurance that might be worth considering – income protection insurance. Income protection insurance (or Permanent Health Insurance) is a type of insurance that protects you if a situation arises in which you cannot work for any period of time by giving you a replacement income for that period. In purchasing income protection insurance you are essentially purchasing peace of mind that you won’t fall behind with your mortgage or loans or face a drop in your current lifestyle if a rainy day comes along unexpectedly.

Ok, So How Does Income Protection Insurance Work?

It’s actually very simple. You, as the contractor, take out an insurance policy with a specialist contractor Permanent Health Insurance provider and they agree to pay you a percentage of any lost income if you have an accident that puts you out of work or you cannot work due to ill health. How much that policy costs will depend on the deferred period (the waiting period) you have selected. The deferred period is the length of time that you have to wait while out of work before the policy starts to pay out. Normally, this period will be anything between a month and a year. It is up to you to decide how much time would work for you but obviously the longer you are able to wait for payment, the lower the premiums on your insurance will be. If you opt for the shortest period – 1 month – then you will pay a lot more in premiums but of course you would also be covered a lot quicker in cases of injury or short term illness. On the other hand, if you were only worried about long term illness and had some savings put by you could pay much cheaper premiums but have to wait between 6 months and a year for payment. Those premiums are paid out of your net pay and if you were to make a claim at any point the replacement income would be paid back to you directly without any added taxation issues.

Most permanent health insurers will let you cover yourself for an amount up to 65% of your salary and dividends (gross) and some providers will also include split dividends. As soon as you no longer require cover you can cancel anytime without having to give notice or face penalty charges.

How Do I Choose The Best Income Protection Insurance For Contractors?

With hundreds of different providers out there all offering variations on the same sort of policy, how do you find a policy that is exactly right for you?

The first thing you should do is draw up a list of exactly the features you are looking for from your insurance – the preferred length of the deferred period, the amount you want to pay for premiums, how much income you want to cover etc. When you do all of this, make sure you are realistic about how much income you will actually be needing if disaster strikes. As mentioned above, you are normally allowed to protect up to 65% of your current income, but you might decide to protect less than this in order to reduce those premiums. Ask yourself how much you will actually need to live off if the worst happens and you are out of work for a long period. You will also need to check the policy to make sure that the figures they quote you are inflation proofed. Because of how inflation works, what you think you can live off right now will not necessarily be manageable in 7 to 10 years time. If you want to cover yourself against inflation, make sure the policy you join has something called indexation (also known as escalation) which gives you an incremental increase in the amount insured every year. Also, make sure that your policy covers you up till your date of retirement. That’s because if you are seriously injured you might never be able to return back to work so it is prudent to cover yourself all the way until retirement!

Does Income Protection Insurance Cover Dividends?

Next, you want to ensure that the insurance policy you sign up with covers your dividends too. Most likely you will be using a contractor insurance specialist who will know their way around contractor financials and will understand how your income works. Because a large part of most contractors’ income comes through dividends it is obviously essential that these are covered in any policy.

Is Income Protection Insurance Industry Specific?

You also need to check that the policy will cover you against specifically being unable to work in your particular contracting industry. Why? Because a number of policies will only pay out if you are not able to work in any role, rather than just your contracting role. You absolutely must avoid policies with this clause in them, otherwise, the insurance company could argue that though you cannot work in your contracting role, you could still do some kind of menial labour – and therefore they would not pay you.

Lastly, and most importantly, once you have chosen a company, do your research on them. You need to have confidence that they will do the right thing if you ever need them and not try to wriggle out of it. Before you sign up it is perfectly reasonable to ask the company for some statistics about how often they have paid out in similar circumstances and for instances when they haven’t paid out. Similarly, ask your own financial advisor and your insurance broker what they can tell you about the company and if they have had any experience with them in the past and do your own research on the internet to see how other contractors have reviewed them.

Health Insurance for Contractors

After sorting out their main contractor insurance policies (such as public liability insurance and professional indemnity insurance) which look after their businesses, most contractors turn next to the other area that they used to have covered when they were working in paid employment for a larger company – health insurance. And the first question that all contractors ask is ‘what health cover can I get via my limited company?’

Claiming Medical Expenses Through Your Limited Company

In a nutshell, your limited company is permitted to cover the costs of as many expenses of a medical nature as is necessary (or as you want) but you personally will be taxed the value of the benefits in kind that you receive as part of the company. Additionally, your limited company will also be required to pay its Employer National Insurance contributions (also known as NIC’s) at a rate of 13.8% of the value of the benefits in kind. To put it another way, you can only get out of paying a personal tax on any health and medical related benefits if your company itself benefits from paying that expense. To take one example, businesses are permitted to pay for the eye tests of their employees if those employees use computers, but if they want to pay for their employee’s health insurance then both the employee and the company have to pay additional tax. Below we will look at these in a bit more detail, starting with Health Insurance:

Contractor Health Insurance – Is It Worth It?

When it comes to contractor health insurance, your company is permitted to pay for the cost of your personal health insurance and then it is allowed to offset the costs against its bill for corporation tax. However, as mentioned above, because you will be benefiting personally from the health policy, you will also have to pay some extra tax on the value of that benefit. The exception comes if you are contracting overseas, in which case the costs of medical treatment are then allowable and no BIK (benefits in kind) charges will apply.

With all that in mind, it is often the case that it is better to get your health insurance through your limited company as firms tend to be offered better value and more comprehensive cover than individual contractors. Indeed, the latest figures from the government show that more than 2.5 million employees in the UK currently get their health insurance from their employers, proving that it is a decent perk and worth considering. Nevertheless, it is worth sitting down with your accountant and working out the difference between the policies you would get on your own or through your company and which would work out cheaper in the long run. 

Permanent Health Insurance for Contractors

Permanent health insurance policies are policies which cover you in case something happens that means you are no longer able to work. Depending on what stage you are in your contracting career, the costs of insurance will vary greatly. That’s because you will be insuring yourself based on how long you might be out of work and how much you wish to receive in the event of making a claim on the policy, as well as what is known as the deferred period, which is the time between when the claim is made and when the payments start. As with other policies, the cost of permanent health insurance can be taken up by your limited company and then offset against tax. However, in the event of you making a claim on the policy, BIK charges will apply on any payments that you then receive. On the other hand, should you pay for the policy out of income post-tax, the payments that you might receive at a later date would be free of tax.

Eye Tests

As mentioned above, eye tests are allowable business expenses if you sit at a computer for any part of your work and you will not face any BIK liability.

Can Contractors Claim For Medical Check Ups?

You are also permitted to claim back the cost of one medical checkup and one general health assessment per employee at the company without facing any BIK liability. A health assessment is defined by HMRC as an assessment that is used  “to identify employees who might be at a particular risk of ill-health.” And they define a medical check-up as a “physical examination of the employee by a health professional for (and only for) determining the employee’s state of health.”

Consequently if you, as an individual, had already planned to have a health assessment then it would be worth your while doing it through your limited company as you won’t be taxed on any benefit from it.

Is Medical Treatment An Allowable Expense?

Medical treatment can be seen as an allowable expense if it is needed for an injury that occurred while you were going about your contracting work. Additionally, as mentioned above, medical treatment that is needed whilst working overseas is also allowable as a non-taxable expense. 

Can I Claim for Membership of a Gym or Health Club?

This one is unlikely to fly. It is very difficult to claim gym memberships as legitimate business expenses. Why? Because although a company would certainly benefit from its employees being healthy, the cost of them being healthy still needs to be borne by the employees themselves. If the company was to pay the employees gym membership then it would also have to pay employers NIC’s on the cost and then there would also be BIK charges when it comes to paying tax at the end of the year. For a contractor with a limited company, it is most likely better value just to get the gym membership themselves.

How Umbrella Contractors Can Still Claim for Travel and Subsistence

The issue around umbrella companies and expenses has long been a contentious one between HMRC and the contracting sector and it remains so to this day, particularly when it comes to travel and subsistence. In this article we will take a brief look at the changes to travel and subsistence expenses and how it is still possible to claim them whilst working for an umbrella company.

What changes have been made to travel and subsistence expenses?

HMRC have, in their wisdom, decided to restrict the ability of certain contractors to make claims for travel and subsistence expenses that are free of NIC’s and tax. This effectively means that all that commuting – by train, bus or tube – that is part of your contracting job and covered by expenses up until now, may well start to pinch on your finances a little bit more.

Ouch! Who Do These Changes to Travel and Subsistence Expenses Affect?

These changes will be relevant to all contractors who are personally performing (or who are under obligation to perform) their contracting services for another business or person through employment intermediaries. These could include:

  • Umbrella Companies.
  • Personal Service Companies (if they are within IR35.)
  • Recruitment Agencies or Employment Agencies.

These new regulations, introduced via The Finance Bill 2016, are only applicable to contractors who are seen as being under the supervision, direction and / or control of their client. HMRC describes these contractors as being under SDC via the ‘manner’ that they are asked to do their contracting work. And that there is the rub – the contractors don’t need to actually be subject to any real supervision, direction or control. Bizarrely, they just need to be seen as being subject to supervision, direction and control. By making this change in distinction, HMRC are effectively massively widening the numbers of contractors who can get pulled into IR35.

 

Why Have They Made These Changes To Travel and Subsistence Expenses Then?

Up until the 2016 legislation umbrella contractors were given overarching contracts that enabled them to make a claim for the costs incurred with their home / work travel. This expenses relief was never offered to permanent workers employed by companies and was thus highlighted by HMRC and the Chancellor as being unfair (in both the 2014 Autumn Statement and the 2015 budget.) In that 2015 budget, the chancellor described the rule change as being for the purposes of placing contractors on a “level playing field” with their permanent working counterparts who were unable to claim such expenses.

And What Impact Will The Changes To Travel and Subsistence Expenses Have?

The biggest impact that will be seen from these changes is that there will be a significant reduction in the take home pay of affected contractors unless their clients are willing to do for them one of two things:

  • Make increases to the rates being offered for their assignments or
  • Help minimise their losses.

A decrease in contractors net rate of pay could also lead to them being less keen on travelling longer distances if they aren’t able to claim any relief on their travelling costs. For many contractors, commuting more than a short train or car ride could soon become something to be avoided.

What About Contractors At Temporary Sites?

Between the Social Security (Contributions) Regulations of 2001 and the Income Tax (Earnings and Pensions) Act of 2003, the law still says that workers can claim expenses when moving from home to a temporary workplace (provided they don’t breach the 24-month rules.) To take an example, imagine a contractor called George who works for an umbrella company and lives in Hastings. He has a contract in South London and commutes there every day. Based on the new travel and subsistence rules George will not be able to claim expenses on that daily commute from Hastings to London. However, if George was required to make a one-off journey to Birmingham for a one-off business meeting, he would be able to claim for that – because it is not his normal workplace.

What About Umbrella Company Contractors?

Umbrella company contract workers can, despite what most people think, still claim for travel and subsistence in a compliant way and without causing their umbrella companies any excess admin and paperwork issues. They can do so, as mentioned above, provided that no one has the right to supervise, direct or control them “in the manner which” they do their contracting work. And HMRC offers some guidance as to the definition of supervision, direction and control:

Supervision

Supervision is where someone oversees someone else doing their work, in order to ensure that the worker is doing the work that they are required to do and to ensure that it is being done in the correct way to the correct standard.

Direction

Direction is where someone is making someone else do their contract work in a certain way and  they do this by providing the worker with instructions, advice and guidance as to how they must do that work.

Control

Control is where someone dictates what the work is that a person does and dictates to them how they are to go about doing that work. The concept of control also includes cases where one person has the power to move a contract worker from one job onto another.

As with most things it is the wording of the legislation that is crucial. HMRC’s reference to SDC being applied ‘as to the manner’ means that contractors can be seen as being subject to supervision to a degree, as long as they aren’t being given detailed instructions as to how they do their work.

And Finally, Why Umbrella Companies Hate The New Rules …

The combination of the highly subjective SDC tests provided by HMRC and the somewhat ambiguous guidance as to supervision direction and control has led to a lot of grumbling on the part of umbrella companies in recent months. The feeling is that these new compliance burdens are starting to mean that the processing of expenses will soon no longer be worthwhile. That’s because the umbrella companies are responsible for providing proof to HMRC that their contractors are not subject to SDC rather than the other way around. On the other hand, HMRC argue that they are not prescriptive in what evidence they will consider and say each case will be viewed based on its individual arrangements. This will leave the status of a contractor as indeterminate until HMRC have given a final ruling.

IR35 Business Entity Test for Contractors – questions and processes.

As of April 2015 the business entity tests are no longer being used. HMRC has, however, given a commitment not to investigate any contractor who took the test and got a low-risk score, for three years.

One way of checking your IR35 status as a contractor is to take HMRC’s online business entity test. This assesses both your IR35 risk and your chances of being investigated. Brought in in 2012, the test is based on twelve questions online which contractors working through limited companies can work through. Each of these twelve questions has a set weighting and depending how they answer the questions and the score they receive, contractors will be able to see what level of risk they are. The risk categories are divided into low, medium and high.

 HMRC has designed the test with the aim of screening limited company contractors and being able to then focus most of its attention onto the high-risk band contractors. They are the ones most likely to have compliance issues and be within IR35 so it makes sense for HMRC to check them first. Lower risk contractors who can provide proof to back up their low scores on the test will be less likely to have to go through any kind of HMRC status enquiry and will not need to be investigated for another 3 years.

On the other hand, anyone in the medium or high-risk categories is likely to feel the full force of an IR35 status enquiry. As any contractor knows, this can lead to having to pay back taxes and NIC’s, interest and penalty payments as well as losing expenses. 

How It Works – The IR35 Business Entity Test Process

The business entity test process begins with HMRC asking the contractor if they have thought about IR35 and if they consider themselves to be outside of the IR35 legislation. If so, they go on, can the contractor provide evidence to support their responses. At that point, any contractors who are able to provide that evidence and prove that they aren’t in false employment – and can show they are part of a genuine independent contracting business – will have their IR35 status enquiry halted straight away and will not be required to do it again for at least 3 years.

Once completed, a business entity score is something a contractor can use to help demonstrate that they are definitely ‘in business’. Nevertheless, it is still important for contractors to make sure they keep using best IR35 practice at all times.

How It Works – The IR35 Business Entity Questions

For your reference we have listed the twelve questions (and their weighting) which make up the HMRC business entity test:

  1. Does your business rent or own business premises which are separate both from your home and from the end client’s premises? (Yes = 10 points)
  2. Do you as a contractor need Professional Indemnity Insurance? (Yes = 2 points)
  3. Efficiency – Have you, as a contractor, in the past 2 years, received full payment for any work which you completed ahead of schedule? (Yes = 10 points).
  4. Assistance – Does your contracting business use any other workers – who contribute 25% or more towards your turnover? (Yes = 35 points).
  5. Advertising – Have you spent in excess of £1,200 on advertising in the past year? (Yes = 2 points).
  6. Previous PAYE – Have you been previously employed by your current client, on a PAYE basis? (Yes = take off 15 points).
  7. Business Plan – Does your contracting business have a business plan, and does it have a business bank account? (Yes = 1 point).
  8. Repair at Own Expense – Would your business be required to pay to fix any mistakes you have made at work? (Yes = 4 points).
  9. Client Risk – Have you been unable to recover any payments for a client at any time in the past 24 months that were worth at least 10% of your business’ annual turnover? (Yes = 10 points).
  10. Billing – Do you invoice clients before being paid, and do you negotiate your own payment terms? (Yes = 2 points).
  11. Substitution – Are you allowed to provide a substitute if you are unable to perform your contract duties? (Yes = 2 points).
  12. Actual Substitution – Have you actually had to use a substitute over the past two years, and have you been responsible for supervising and paying the substitute? (Yes = 20 points).

High Risk = 0 – 10 points

Medium Risk = 11 – 20 points

Low Risk = 21 points and above. 

With the score ranges above, it is clear that a high number of contractors will find themselves in the high and medium risk bands, despite their best intentions. 

Remember, It’s Not Just About The Business Entity Test!

However, contractors should always remember that these business entity tests are simply a kind of screening process and are there to help the Treasury focus its compliance investigations in a better way. The legislation behind the tests is still the same as it always was. If a contractor was to find themselves being investigated all that would matter would be whether they were within the accepted limits of that legislation and that the case law on IR35 was on their side. Everything else, including the business entity test, would be irrelevant.

Supposedly the business entity test and the IR35 forum were there to provide a better-administered version of IR35 but in reality, the risk scenarios and business entity test brought in by HMRC merely added, even more, confusion for contractors trying to make sense of it all. Thanks to the business entity test, more and more contractors will have to take part in unnecessary, expensive and probably stressful IR35 enquiries.

How to be IR35 Compliant

Worried about IR35? You’re not alone. Ask any contractor (especially those working via limited companies) what their biggest work stress is, or what they like least about contracting, and you will invariably get the same answer – IR35.

Ever since it was introduced in 2000 by HMRC, IR35 has got stricter and stricter in its pursuit of ‘disguised employees’ to the point where it is now necessary to check and double check every contract for IR35 potential and to conduct yearly IR35 tests on your contracting business to make sure you don’t get trapped. With that in mind, this article offers a brief checklist of issues to bear in mind for contractors who are concerned about their IR35 compliance.

Make Sure You Work For Multiple Clients

One of the easiest protective measures to put in place, and the most obvious, is to diversify your contracting client base. Make sure that you never spend too much time on one client (particularly if you would be working on their premises.) By moving regularly around various clients you ensure you won’t be logging in too many hours/days/weeks with one client, at one location, and giving the impression of being a ‘disguised employee.’

Make Sure You’ve Got Your Own Kit

If you want to look like your business is yours and that you’ve invested in it then it is essential to be able to show that you have spent your own money investing in your own equipment for your own business. Whatever equipment you need for your work, make sure it is your own. The moment you start letting clients buy you equipment or provide you with equipment to work a contract is the moment you open yourself up to falling within IR35.

Put Your Money Where Your Mouth Is

In other words, carry some financial risk! Invest money in your limited company, spend money getting your business started, and take on risk in your working life. This doesn’t mean go gambling at lunchtime with the company funds, just that you work on the basis that if you don’t deliver, or you screw up, you’re prepared to issue refunds or not get paid. If you work and are not guaranteed to be paid then that is an element of risk as you are reliant on your various clients paying you. That is a risk and is a positive thing to show HMRC to stay clear of IR35.

Invoice Wisely

Don’t just issue invoices based on an hourly rate for the work you are doing. You will need to track your time for your own books and those of your clients and you may even want to use timesheets. But you shouldn’t just invoice on your hourly rate. Instead, you should charge on the cost of your hourly rate plus your business expenses. Any business will have operating expenses that it has to find and these should be built into your costs – billing for this ‘bench time’ is expected as it is part of the working hours you spend on your business, but which can’t be specifically attributed to one client. In order to cover all of your bench time costs, it is absolutely necessary to retain a bit of profit from each job towards non-billable hours. And doing so will show HMRC that you are running a business, not just being employed by a client.

Keep Perfect Records

Data retention is your best friend in the battle against IR35. The more information and data you have available showing both your revenue from different clients and your operating expenses (with as much detail as possible) the better case you will be able to build that you are not a disguised employee, rather that you are a business entity.

Register for VAT

Though this is only compulsory for those contractors who earn more than £83,000, any contractor who starts to get near this figure or who expects to be there soon should probably register anyway. Not only will it encourage much better record taking but also it will look more professional and make you look more like an independent business.

Register With The Information Commissioners Office (ICO.)

Similarly, joining up to the ICO for data protection purposes will also look professional and independent.
Spend Money on Advertising – This one comes with dual benefits. Firstly it will get you more clients and keep your name out there. Secondly, it helps you with your IR35 issues. HMRC need proof that you aren’t just working as a disguised employee for one client. If you were not advertising, they would question how clients can find you? So retain records of all the money you spend on advertising your services (as well as the adverts themselves), and keep hold of any receipts for business networking events and meet n greets, business cards, flyers and contracting or industry memberships. Absolutely anything that shows you constantly trying to attract new clients will be useful in arguing your non-IR35 status.

Be Easily Reachable to New Clients

As with advertising, another way to draw a clear line between you and your clients is to have obvious ways of reaching and signposting your business. These should include a business address and an office space to work in and a business website with a business email address.

Learn The Mantra – Supervision, Direction and Control!

HMRC looks for any sign that you are under either the supervision, direction or control of a client. If so, you will be within IR35. There are a number of things you can do to avoid this, and it is worth incorporating them into your thinking when signing new contracts.

Substitution

Make sure you have a substitution clause in your contract. This provides a clear marker that your business is taking on a contract (and that someone else will fulfil the contract if you get sick) and not you as a person.

Keep IR35 In Mind At All Times

As well as the mantra of supervision, direction and control, always keep in mind how something will look if you are ever called in for an IR35 investigation. Getting your mindset right is half the battle. Firstly, as you go about your working life, make sure everything you do is as a business, not something that feels like being an employee of one client. How does something look? How could it be perceived? Keep this in mind at all times. Secondly, if the worst case does happen and you are investigated then make sure you go into the investigation

  • (a) armed with proof of everything discussed above
  • (b) with the mentality of a business owner who works for no one but himself!

IR35 Supervision, Direction and Control Explained

One of the essential factors that HMRC uses to sniff out false employment via IR35 is the concept of ‘Supervision, Direction and Control.’ This is a concept that has undergone a few changes over the years but the basics are still relevant to every working contractor who has a healthy fear of being caught by IR35. In this article we will look at ‘SDC’ in full, in order to help you navigate all that it entails in your working life.

Understanding ‘Supervision, Direction and Control.

The first thing to do is make sure you fully understand the importance of SDC. Contractors these days all understand why control is such an important factor in staying outside of IR35 and SDC is a crucial part of that concept of control. There are four fundamentals that make up HMRC’s control test and they are

  1. (1) What work is being carried out?
  2. (2) When is it being carried out?
  3. (3) Where is it being carried out?
  4. (4) How is it being done?

When it comes to the concepts of ‘supervision direction and control’ it is number 4 that is relevant – are you, as a contractor, being supervised, directed or controlled in how you go about your work for the client? And how do you answer that question? Luckily, HMRC has provided some guidance on this one:

HMRC Guidance on Supervision

As a contractor, you will be deemed to be subject to some kind of supervision if your work involves another person ‘overseeing’ you as you work. This is considered supervision because the person overseeing you is essentially ensuring that you are doing the work you are supposed to be doing and checking that you do it in the correct way. Additionally, if the person overseeing you is deemed to be helping you so that you can improve your skills and depth of knowledge, this training would count as supervision too.

HMRC Guidance on Direction

As a contractor, you will be deemed to be subject to some kind of direction if there is someone from your client company making you do your contracting work in a certain way. A director would be someone who gives you advice, guidelines or instructions as to how to do the work. They might also coordinate with you as to how the work is done while you are doing it.

HMRC Guidance on Control

As a contractor, you will be therefore deemed to be subject to control if someone is telling you what work you are to be doing and how you are to then go about doing it. Additionally, they would be deemed to be controlling you if they also had the power to transfer you from the job you are doing to another, different job.

For more HMRC guidance visit: 

https://www.gov.uk/government/publications/employment-intermediaries-personal-services-and-supervision-direction-or-control/employment-intermediaries-personal-services-and-supervision-direction-or-control

HMRC Muddies The Water Even Further

If it was just those three definitions then it would be relatively simple but HMRC decided to make the test even more difficult to pass. Firstly, they made clear that any person is able to subject you to supervision, guidance and control, not just the end user for you to end up failing the test. Secondly, they also made clear that anyone can just have the ‘right of’ SDC over you in order for you to fail that test (it needn’t be exercised, just present.) Lastly, only one of the three needs to be present in order for you to fail. Just being supervised, or just being directed would qualify you to fail.

This obviously makes things much harder and has been the cause of much annoyance in the contracting community, particularly when HMRC has been quoted as saying more generally that: “Where there are procedures, methods and instructions which must be followed, it is likely there will be SDC over the manner in which the services are provided.”
Nevertheless, there is some reason to be cheerful. In Staples v Secretary of State for Social Services it was ruled that simply giving a brief to a contract worker was not enough grounds for the provider of the brief to be considered as exerting SDC over that contract worker. Additionally, there are of course steps you can take to prevent supervision direction and control.

Steps That Can Be Taken To Prevent Supervision Direction and Control:

Contractual Steps

If you have never been subject to SDC during your actual contract work then the only place you have to be worried about is the contract itself. Thus the contract becomes more important when it comes to the terms that address the right of control and it is essential that there are no clauses that show any exertion of control. If the contractor handles this himself that’s fine but if it is through an agency the contractor may not see the upper levels of the chain. If that is the case it is essential that the contractor asks the agency to put in a clause in the lower level contract which states clearly that all contractual provisions will be mirrored in the upper contract. If not, the contractor is then entitled to sue.

Empirical Steps

After this contractual step has been taken the contractor then needs to put in place a ‘Supervision Direction and Control’ specific Confirmation of Arrangements document. This will be a strategic document that helps to verify the lack of SDC. It does this by making clear that the common features of SDC are not and will not be present in this working arrangement and confirms this by getting the end client, agency and contractor to all sign it.
Additionally, it is worth keeping hold of emails between yourself as contractor and the end client in which you discuss any services requested of you by the client that are not defined in the contract and which have to be done quickly without a chance to clearly define them in another contract. Your input on these emails will be essential in order to show that you cannot be simply moved around jobs at the whim of your client. You should also keep any documents in which the end-client’s requirements are outlined and you have responded with your own requirements and suggestions. Get into the habit of doing this for all of your contracts.

Precautionary Steps – IR35 Insurance.

One thing to bear in mind is that it is possible these days to actually purchase IR35 insurance. Start by checking your current business insurance but it is unlikely that this will cover you. However, if you are concerned about getting caught up in IR35 it is worth looking into one of the many policies out there which will cover your current and future contracts (and sometimes will even cover your past ones too) against the costs of any investigations and demands for tax.

Research The Case Law

Lastly, if you need more information and reference points it doesn’t hurt to read up a bit on the past case law for IR35 infringements. There are a number of prominent cases that have already been before the courts which illustrate that contractors are not always controlled via SDC in the way that HMRC likes to paint them as being.

For example, in ‘Morren v Swinton & Pendlebury Council’, the judge was swayed by the argument that when assessing a highly skilled professional contractor, supervision and control was not really a suitable method for that assessment. And in ‘Marlen Ltd’ a contractor at JCB known as Mr Hughes had been briefed as to what was to be built by a project manager. The engineering manager at JCB said that as a contractor he would be under the control of a number of project leaders. Actually, in reality all that really happened was that they oversaw the project and occasionally checked on the project’s progress. He had to report to senior designers on a daily basis and took occasional instructions but that was all and he was only a small part of a much bigger project, hence the need for this contact. The court accepted that such direction was reasonable in order to make the project run smoothly and this was not therefore a case of SDC and IR35. The court’s argument was essentially that the degree of control has to be judged in context with what is being worked on and produced. Lastly, in the case of ‘Primary Path Ltd’ it was again made clear that the issue of control is more difficult to adjudge when the person has been contracted for their highly specialist skills. When a contractor, Mr Winfield was brought into a team for his very specialist skills to help with one particular project, there was some supervision and direction for that project but when it came to the management of the project as a whole he was given free rein to work how he wanted. The court ruled that the level of control exercised did not go beyond anything you would expect from engaging an independent contractor.

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