If you are a contractor employed through an umbrella company or agency, you may have been offered a way of both reducing your tax liability and increasing your total take-home pay. Sounds too good to be true, right? Well, that’s because it is.

In recent years, HMRC have heard of more and more of these illegal tax-saving arrangements which are, in effect, tax avoidance schemes in disguise.

Despite having been misled by these irreputable firms, you, as the taxpayer, are still responsible for your own tax affairs. You could be at risk of investigation, legal action, and being made to pay all additional tax, interest, and even penalties on the money you owe.

In this article, the Sunny team will look at what these avoidance schemes are, how to spot one, and what you can do to ensure you don’t get on the wrong side of the taxman.

What do these umbrella companies claim?

Many of those caught out by these schemes were told by their umbrella company or agency that their methods were “legitimate”, had been approved by HMRC, and that it was simply a “tax efficient” way of keeping more of your income.

While exact arrangements can differ from agency to agency, the general claim is that the umbrella company will help you to bring home more of your income and reduce your paperwork for you.

The most common claim taxpayers are told by these companies is that they can take home between 80% and 90% of their income and that they do not need to declare this contractor loan scheme to HMRC.

How do these ‘gifts’ work?

You’ll be told that the payment they give you in exchange for work as part of the arrangement is non-taxable as, through an umbrella company, it does not count as income. It does. They will tell you that the money is considered a loan, credit, or something similar. It is not.

The money you receive from your umbrella company or agency – regardless of any agreements you may have in place – is no different to normal income. Since you do not pay these ‘loans’ back, you are still be liable to pay tax and National Insurance Contributions (NICs) on this income you receive.

Some of the more dubious umbrella firms may also say that you have to sign up to an arrangement like this if you want to work for them. Should this happen you should always seek professional advice as to your rights and options. Speak to your Sunny accountant to find out more.

How are payments made?

Again, the details of each scheme can differ depending on the umbrella company you work for. However the following is an example of how many of these tax avoidance arrangements work.

First, you will receive a small payment that has already had tax and NICs deducted from it. Around the same time you will also be given a substantially larger payment with no tax or NIC deductions having been made.

It is likely the second, larger payment will arrive from a different bank account to the first. This may be from overseas, but not necessarily.

When you receive your payslip from your umbrella company, only the smaller payment will show as actual pay. The larger payment will be shown separately and referred to as something other than pay like a contractor loan.

That means the income brought in by the second payment will illegally avoid all tax and NICs that you owe.

How can I recognise a tax avoidance scheme?

Some of these umbrella companies can be quite believable when it comes to convincing workers that their scheme is legitimate. Here are some of the top red flags you should keep an eye open for:

  • The agency promises you’ll be able to keep 80%, 90%, or 95% of your wages and that this will be tax compliant. Bear in mind that the basic rate of income tax is 20% without NICs too. If it seems too good to be true it probably is.
  • Only a small percentage of your salary actually goes through payroll and is subject to PAYE.
  • The rest of your income is made up of a loan, credit, or an investment payment that you don’t need to pay back. The company will also state that this money is not subject to income tax or NICs. This is tax avoidance.
  • The payment from your umbrella company may also be routed through various other companies before it gets to you.

What happens if I use these schemes?

These umbrella companies will try to assure you that their arrangements are compliant with tax law but you should not believe them. The main risk is that, even if you have been coerced into joining the scheme, you will still be held responsible for the tax avoidance.

HMRC will always challenge instances of tax avoidance. If you use one of these arrangements you could be made to pay additional tax, NICs, and interest in the future along with costly penalty fees.

If you think you are involved in a tax avoidance scheme through an arrangement with your umbrella company or agency – or even a firm you have worked through in the past – you should withdraw from it and contact HMRC without delay.

You will still need to settle your outstanding tax affairs but, by informing HMRC directly rather than being caught in an investigation, you protect yourself from legal action. You can speak to HMRC about getting out of an avoidance scheme by emailing [email protected].

If you believe a company is operating these illegal arrangements you should also report them to HMRC.

Stay tax-compliant with Sunny

The best way to avoid getting into trouble through schemes like this is by working closely with your accountant. The Sunny team can effectively manage your finances so you pay the right amount of tax, and can even find ways to reduce your tax liability legally.

Call us today on 01623 559 362 or email us on [email protected] for advice and support.

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