A recent reveal of an umbrella company scheme has saved contractors from facing huge tax bills. While this isn’t the first tax evasive procedure umbrella companies have practiced since the changes were made to the IR35 in the public sector. Contractors are depending on umbrella providers to help save up their earnings through such tax evasive methods.

Functioning of the Umbrella Scheme

The scheme proposed by umbrella providers functions in a way where the providers issue the contractor’s money as advance gross payments. Though it seems safe in the beginning, the providers hide the fact that the contractors have to pay tax at a later stage. The Umbrella providers conveniently disguise these payments as bonuses keeping the contractor in the dark about the tax dues.

At first, the umbrella provider will make the payment in two parts. The first part or sum is termed as the salary and this is subjected to Pay As You Earn (PAYE) income tax and National Insurance Contributions(NICs). The second payment or sum is paid to the contractor under a ‘taxable discretionary bonus’. The contractor, however, is unaware of the fact that this money is taxable after a while.

The reason this money isn’t taxable at first is that the payment is made in the form of an advance by the provider. But, neither the umbrella company nor the agency explains to the contractor that s/he is liable to pay tax for the amount at a later stage.

The umbrella company asks the contractor to state about 79% of their gross income as a sum of bonus. This discretion makes the contractor feel as though they’ve earned the desired income. In some cases since these umbrella companies are recommended to the contractors by the agency, there is not much the contractor can do.

Contractors in an attempt to save their income and take home the best salary possible, go blind to the risks of engaging in such false schemes provided by the umbrella companies. It is important to remember that the HMRC will go after the contractors for tax dues and unpaid NICs. The umbrella company is under little to no risk and it is the contractor who suffers the extra tax penalties and liabilities.

This discrepancy and lack of knowledge to the contractor puts them at a high risk. Despite HMRC’s several attempts at keeping these umbrella companies at bay, such false schemes are growing in the wake of the IR35 reforms.

How To Identify Non-compliant Umbrella Companies?

1. If your contractor talks about tax savings make unrealistic promises of taking home a huge chunk of your pay which is greater than the pay you take home outside IR35.

2. If your contractor or umbrella provider deviates from the standard practice, you can be sure that it is not genuine.