If you’re required to use an umbrella company for your payroll, it’s understandable that you may decide to shop around and choose the umbrella company that offers the highest take-home pay retention. However, as we’ll explain in this article, all umbrella companies (the compliant ones) will process your payroll identically, and your retention between providers shouldn’t vary. However, there are unscrupulous tax avoidance schemes out there that’ll offer you noticeably higher pay retention – sometimes upwards of 90%. While using one of these arrangements may be tempting, we urge you to avoid them at all costs. Keep reading, and we’ll explain the warning signs of a tax avoidance scheme and why they should be avoided.
How compliant umbrella companies should operate (PAYE)
Compliant umbrella companies operate HMRC’s tax system called ‘Pay As You Earn’. This means they receive your assignment rate from your agency (or direct from the end client) and make the necessary deductions according to UK tax law. You’ll then receive your net salary supported with a payslip.
The team behind Umbrella Company Calculator set out to create the free tool to try and discourage umbrella companies from deliberately inflating pay projections for temporary workers. Unfortunately, it was brought to our attention that some umbrella companies intentionally used inaccurate formulas to convince temporary workers they would retain more of their earnings than other umbrella companies in the marketplace. This isn’t the case – as all umbrella companies process payroll in the same fashion. The idea of honest contractors and freelancers being tricked into using the services of an unethical umbrella annoyed us – hence why we built our umbrella company calculator – to provide accurate and transparent illustrations.
What is tax avoidance?
Before we delve into the world of tax avoidance schemes (often referred to as ‘disguised remuneration’ arrangements), we wanted to define what tax avoidance is. Having conducted some research into the topic, it’s apparent that the very best definition of tax avoidance is published on the government’s website.
“Tax avoidance involves bending the tax rules to try to gain a tax advantage that was never intended. It usually involves contrived transactions that serve no real purpose other than to artificially reduce the amount of tax that someone has to pay. It is not the same as effective tax planning but is often promoted as such.
Tax avoidance does not pay, as most schemes do not work. People who use tax avoidance schemes can end up paying not only the tax they should have paid, but also interest and potentially a penalty. This is on top of the fees they paid to the person or business offering them the scheme. Everyone is legally responsible for their tax affairs and for paying the correct amount of tax even if they get someone else to do it for them.
Not paying the right amount of tax also means that our vital public services like schools and hospitals don’t get all the money they should. Don’t get caught out by tax avoidance.”
Tax avoidance is technically legal. However, engaging with a tax avoidance scheme could have serious consequences in the future because HMRC is retrospectively punishing those who engage with them. Take it from us – tax avoidance isn’t worth it.
How to spot a tax avoidance scheme
Compliant umbrella companies operate PAYE. Therefore, if you require the services of an umbrella company, you should expect to retain roughly 50 to 70 percent of your pay. This figure is entirely based on your circumstances and is just an estimate. Multiple factors can vary pay retention.
We’re going to summarise the most common warning signs of a tax avoidance scheme, and the first sign follows on from the statement above.
Inflated pay retention
It’s common for some payroll schemes (sometimes claiming to be “umbrella companies”) to advertise inflated pay retention as a benefit of using their service. We’ve seen some schemes promote the opportunity to “pay less tax” and to keep upwards of 90% of pay after all deductions. These schemes are unethical and should be avoided.
Lack of trading history
There are some very well-established umbrella companies and payroll intermediaries in the United Kingdom. For example, some of our featured umbrella companies are backed by professionals with over 20 years of industry experience. We recommend you choose a provider that’s well-established within the marketplace.
Directors without any experience
In recent cases, randomly assigned directors have been chosen as the figureheads behind unethical arrangements called mini umbrella companies (MUC). It’s worth researching the payroll companies you’re interested in using and making sure the people behind the businesses have plenty of experience. Mini umbrella companies are particularly evil because many honest workers were enrolled on them without their knowledge.
Not all but most unethical tax avoidance schemes and disguised remuneration arrangements are located offshore in known tax havens. As a UK taxpayer, it’s not unreasonable to expect an umbrella company you use to be based in the UK too. Also, if you’re working in the UK, you should expect to pay UK taxes. Some arrangements will promote the opportunity to avoid UK tax and pay less taxes than UK-based umbrella companies. If you come across a business like this – run away quickly.
Just a quick bit of advice – known tax havens include the Cayman Islands, Isle of Man and the Channel Islands. If you notice a payroll provider is based in these locations, it’s unwise to engage with them.
Non-taxable payments and unusual payment structures
Disguised remuneration is when a worker receives payments via unusual arrangements to avoid tax. Over the years, some very creative disguised remuneration schemes have been identified and shut down. For example, the following are examples of real disguised remuneration arrangements:
- Paying workers minimum wage with the rest of their salary paid as a loan (to avoid tax).
- Paying workers minimum wage and then issuing the rest of their salary in job board tokens which were instantly transferred into their cash equivalent (to avoid tax).
- Paying workers minimum wage and then distributing shares in the payroll intermediary – only to transfer the shares back into cash immediately (to avoid tax).
Notice anything in common with the above? They are all unusual ways to process payroll, and they’re all tax avoidance! These are just three examples, but there are many, many more. We’re sure you’ll agree that they sound unusual, unnatural and a deliberate attempt to bend the rules. Please never be tempted to use an arrangement like those above, and if you come across a scheme that you’re unsure about, seek professional guidance.
“HMRC does not approve schemes”
HMRC make it clear on their website that they do not “approve schemes”. Therefore, if you discover a payroll company promoting themselves as “HMRC approved”, avoid them. They’re almost certainly a tax avoidance arrangement, and they’re lying in their advertising.
More than one contract
It’s been known for some operators of unethical schemes to ask temporary workers to sign multiple contractors. When you join an umbrella company, you’ll be required to prove who you are and complete a registration process. You will then be required to read, sign and return a Contract of Employment – assuming you’re happy with its content. If you discover an arrangement with multiple contracts for you to sign – it’s an indication you’re enrolling on something dodgy.
Lack of professional accreditation
The Freelancer and Contractor Services Association (FCSA) and Professional Passport are the two leading professional bodies in the UK committed to ensuring the supply chain of temporary workers is compliant. We strongly recommend that our readers only consider using an FCSA or Professional Passport accredited umbrella company or payroll provider. Why? Because to achieve one of these accreditations, organisations must undergo a series of audits and assessments to prove they operate in accordance with HMRC’s rules and regulations. Obtaining FCSA or Professional Passport accreditation isn’t easy and shows genuine commitment from the UK’s most compliant businesses.
Our partner site umbrellacompanies.org.uk has a live directory of FCSA accredited umbrella companies and Professional Passport accredited umbrella companies.
Always visit the government’s website for the latest news and guidance
This article has set out to summarise the warning signs of a tax avoidance scheme and has been put together by consulting the government’s website. In particular, a piece of guidance called Spot the signs of tax avoidance has been extremely useful. Please check it out for yourself.
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