First-Time Contracting: Contractor Compliance in the UK IT Market

Considering joining the IT contractor market but confused about contractor compliance? You may have heard of a number of laws and regulations governing contractors, however, depending on whether you operate through a Personal Service Company (PSC) or an umbrella company, these laws will affect you differently.

This article will guide you through the various laws and regulations, exploring how they may impact you as you prepare for your first contract.

Personal Service Company or umbrella company?

When choosing to become a contractor, there are two choices: whether to set up your own Personal Service Company (PSC) and register a Limited Company with Companies House, or become an employee of an umbrella company. Which option suits you best will depend on your personal circumstances and preferences, including, how long you wish to stay contacting, the types of contracts you are working on, and the level of involvement you want to have.

If you are working on contracts Outside IR35, wherein you have a good amount of autonomy over the services you provide and your working conditions, operating through a PSC can have significant benefits, namely being more tax efficient. However, there are significantly more regulations and administrative tasks to contend with.

For those working on contracts Inside IR35, there are no financial benefits to setting up a PSC and a number of advantages to working under an umbrella company. An umbrella company takes care of the employer costs, your tax and national insurance contributions, as well as all other deductions. However, there is a fee for their services.

If you are working on both Inside and Outside IR35 contracts, it is possible to keep your PSC dormant or receive income payments that have already been taxed via PAYE, until you secure a new Outside IR35 role.

Notwithstanding the IR35 determination, whichever route you want to take, whether you wish to set up your own PSC or work through an umbrella company is up to you, but the benefits and drawbacks of each option will change depending if you are working on Inside or Outside IR35 contracts.

Contractor compliance: Key laws and regulations

IR35

In simple terms, IR35, or the Off-Payroll Working Rule, is a legislation designed to make sure that contractors are paying the correct amount of tax. You can be deemed Outside IR35 or Inside IR35 depending on the type of contract you take on.

Outside IR35 is designated to contracts where you have autonomy and control over the services you provide to the client and your working conditions. Whilst, in contracts designated Inside IR35, you are given similar supervision and direction by the client as a permanent employee would. The IR35 legislation determines that if you are working Inside IR35, you will be taxed via PAYE, either by the end client, a recruitment agency, or an umbrella company. Outside IR35 contracts, on the other hand, are paid to you via your PSC or Limited Company where you will pay tax directly to HMRC and pay yourself through a salary and dividends.

However, it is important to understand that it is the end client’s responsibility to determine whether a contract is Inside or Outside of IR35, unless they are a small business as set out in the Companies Act, through a Status Determination Statement (SDS). If you disagree with this determination, you can challenge the client, who will need to provide evidence for their SDS.

(PSC)

If you are operating under your own PSC, the Status Determination Statement (SDS) decided upon by your end client will be crucial to how you are taxed. If you take up a contract that is Inside IR35, you can decide whether to switch to working for an umbrella company to receive payment that will be taxed via PAYE or keep your PSC dormant until you secure an Outside IR35 contract.

(Umbrella company workers)

IR35 determinations do not matter if you are working through an umbrella company as no matter what, you are being taxed via PAYE. If you are solely working on Outside IR35 contracts, you may want to consider setting up your PSC.

Companies Act

(PSC)

When setting up your own PSC, or Personal Service Company, you need to act in accordance with the Companies Act. This act codifies the duties of a director, simplifies administration and improves the rights of shareholders. Whilst you do not need to read it in its entirety, you should understand what you are taking on as a director and business owner, as well as how to conduct your business in accordance with contractor compliance.

Agency Worker Regulation

(Umbrella company workers)

The Agency Worker Regulations 2010 are a set of regulations that will be relevant to you if you are working via an umbrella company or recruitment agency. This legislation, which protects you, is directed towards end clients and recruiters to ensure that all workers have equal treatment to permanent employees after a qualifying period of 12 weeks, with requirements for equal pay, rest breaks, holiday pay etc. This regulation does not include contractors who are providing services via their own PSC.

Tips for contractor compliance

(Both PSCs and umbrella company workers)

Understand basic contract law

ALWAYS read and understand your contract. You need to understand liabilities, including any personal ones, and key responsibilities. Do not sign a contract without looking at it, assuming it will all be fine. I have heard contractors say, “If I knew that was in the contract, I wouldn’t have signed it!”, but they did sign it and only when something went wrong they didn’t like what it said.

Create a budget

When looking into becoming a contractor, it is important to forecast all your costs at home that will “keep the lights on”, such as mortgage costs, bills, food and childcare. Ideally, you should have 6 months or more of outgoings saved in case you are caught between contracts for an extended period of time.

(Umbrella company workers only)

Too good to be true

Some non-compliant umbrella companies may offer you great rates on deductions and promise you ways to avoid paying tax. Do not take this at face value. If it seems too good to be true, it probably is! If you are unsure, you can enquire with a reputable accountant for advice, ask your recruitment agency to recommend a compliant umbrella company, or check the umbrella company’s certification. For example, FCSA or Professional Passport accreditation is given to umbrella companies that have been audited and deemed to be operating compliantly.

(PSC’s only)

Get a good accountant

It is not a legal requirement for you to engage an accountant, however, it is strongly advised, and you can offset this cost as a business expense. I have seen contractors that go for the cheapest accountant they can find, and I appreciate why they do it. However, paying a little more for an experienced accountant is worth it as they will help advise you on tax planning, financial management, as well as ensuring that your PSC is legally compliant.

Set time aside each month for admin

Having spoken to thousands of contractors, I can tell you that the smart ones will put aside time each month for their bookkeeping – including checking sales and purchase invoices, and doing their admin, in order to stop simple tasks becoming a mountain. Some contractors also employ a relative or a spouse to do their admin for them, but doing so means you need to understand employment law and the right procedures for employing someone.

Don’t forget tax

I have met contractors who do not budget for their tax along the way. They spend everything they earn and “worry about the bill when it lands”. However, when they are then given a large tax invoice, they struggle to pay it and may even take out a loan to pay their tax bill off. With the insecurity of contract work, they may struggle to secure contracts to cover these payments. I always advise to separate out tax straight away and put it in a high interest savings account to accumulate until you need to pay.

File VAT returns on time and accurately

Always file your VAT returns on time and understand what you can and cannot claim as a business expense. Personal expenses should not be filed as a business expense. I knew a contractor who claimed that expensive watches were a “business tool” to help them look the part, and that their vet bills and dog food were business expenses because their pet was their home office guard dog – as you can imagine, HMRC wouldn’t accept these explanations during an investigation and the contractor faced a hefty tax bill. I have also found that if a contractor has been under the radar by HMRC for questionable expenses, they run the risk of more regular inspections in the future which are time-consuming and stressful.

Contractor compliance: Insurance

(PSC and umbrella company workers)

Insurance is essential and can protect you from significant risk and high costs. Some clients and recruiters stipulate a certain level of insurance cover is needed for certain contracts. Though, keep in mind that if you take out insurance and then cancel it before your terms are finished, in my experience it can go ugly. Insurance companies communicate when policies are cancelled, which can create a number of problems between you and the client.

Professional Indemnity Insurance – covers claims rising from professional errors and omissions, such as negligence, loss of data, reputational damage etc.

Public Liability Insurance – covers claims due to accidental injury or property damage.

Income Protection – coverage during times of illness, injury, disability or other unforeseen circumstances.

IR35 Insurance – covers expert’s fees in handling an HMRC enquiry and a full policy including liabilities.

Understanding contractor compliance is crucial before starting your first contract. If you are planning on operating through your own PSC, you need to fully comprehend what you are responsible for and protect yourself from risk. For those who are working through an umbrella company, whilst this route removes the majority of the risk and liability that can come with contracting, it is still important to be aware of them in case you wish to set up a PSC later on. Contracting can be highly profitable and advantageous for the right professionals, but you must understand all aspects of contracting before you get started.

Ready for your first contract?

If you want to enter the IT contractor market, check out our guide on everything you need to know to secure your first contract. Additionally, check out our latest contract opportunities or send in your CV here.