Contractor Tax, PAYE and Umbrella Companies Explained

Contractor UK

If you are a contractor or considering contracting in the UK then there are a number of important considerations to be made.

There are a number of benefits from being a contractor rather than an employee:

  • Being a contractor you can normally command a higher hourly rate than if in normal employment;
  • You have varied jobs and places of work;
  • You gain different experiences to develop your CV;
  • Greater flexibility allows you to take longer periods of time-off between contracts; and
  • In some cases you can lower your tax bill by claiming allowable expense deductions.

On the other-side of the coin being an employee also has it’s benefits:

  • Job Security;
  • You are protected by Employment Law;
  • Develop relationships with colleagues;
  • Promotion Prospects; and
  • Other Benefits i.e. Group Pensions, Healthcare, Sick and Statutory Pay.

Common Careers for Contractors:

  • IT Contractors;
  • Engineering Contractors;
  • Building Contractors;
  • Medical Contractors;
  • Public Sector Consultants;
  • Freelance Consultants; and
  • Agency workers.

Contractor Tax

If you are considering contracting then you have probably heard various stories regarding your tax position.

Many employers and recruitment agents are also worried about the tax implications of using contractors.

Contractor IR35

IR35 is Government legislation relating to Intermediaries introduced on 6th April 2000 in the Finance Act 2000. It was introduced to stop Contractors avoiding tax and National Insurance through the use of Intermediaries such as Personal Service Companies or Partnerships.

Historically people saved National Insurance contributions by drawing out “wages” via a dividend. IR35 ensures contractors pay tax similar to what you would pay if you were employed rather than being a contractor.

Because of concerns over IR35 most employers or recruitment agents require contractors to submit tax invoices from a limited company for their time. This gives contractors 2 options. Either setting-up your own limited company or joining an Umbrella Company.

Contractor Own Limited Company

Setting-up your own limited company helps puts you outside the scope of IR35 and can help you build up your own brand and reputation. You may also be able to expand and recruit other contractors. You also benefit from “Limited Liability” status which helps protect any personal assets you have.

Setting-up a limited company (and being a director of your own limited company) does however give you certain statutory responsibilities and costs:

  • You need to prepare accounts, tax returns and have a system for invoicing and collecting funds owed;
    There is an initial cost in setting-up a limited company;
  • You need to ensure your company has all appropriate insurances; and
  • Accountancy costs in preparing year-end accounts and tax returns.

Contractor Umbrella Company

By joining an Umbrella Company you in-effect become their employee and this clarifies your tax status.

The umbrella company then set-up a legal contract with your recruitment agency or end client for the services you are going to deliver. You are also issued with a contract of employment. It is still your main responsibility to gain new work.

Each week you submit to the Umbrella Company a timesheet and expenses claim and they take care of the invoicing, cash collection, tax calculations and paying you (and you are issued with a payslip and breakdown of payment).

The payment to you is based on the profit of your work done less the Umbrella Companies margin (normally around £20 per week). In calculating the profit the Umbrella Company have to deduct from the amount they receive any employers National Insurance they have to pay on your earnings.

Benefits of joining an Umbrella Company include:

  • No more tax or administration worries;
  • You benefit from a back office function to take care of all accounting and tax issues;
  • Most Umbrella Companies include all required insurances in their margin;
  • You are protected by the Umbrella’s Limited Liability status;
  • You are protected by Employment Law and benefit from Statutory Maternity and Sick Pay;
  • Many Umbrella’s offer Group Pension Schemes and Healthcare;
  • The Umbrella Company will claim back expenses you are allowed to claim off your client; and
  • The Umbrella Company can advise on allowable expenses in calculating your tax liability (examples of allowable expenses include travel, Subsistence and accommodation).

Which ever option you prefer (own limited company or an Umbrella Scheme) we can help.

We work in association with PayMatters LTD who can be contacted for FREE advice on 0800 121 6513.

Contractor Tax Calculator

Contractor Calculator offer a number of free calculators which can calculate your take home pay, tax payable or how much you need to charge.

Visit Contractor Tax Calculator

Contractor Trade Bodies

Professional Contractors Group

At the heart of the freelance community, PCG represents and gives a voice to all those who choose to work for themselves. From just £120 (plus VAT) a year, membership provides:

  • Tax Investigation Insurance
  • Draft Contracts vetted by experts
  • Expert guides to IR35 and Family Business Tax, plus full guidance on MSC Rules
  • Tax and Legal Helpline
  • A range of other benefits and networking opportunities
  • Registration of freelance consultants and contractors to government, professional bodies, agencies and clients

Contractor Other Useful Websites

Contractors Health & Safety Assessment Scheme

The scheme is open to the public and private sector. The membership extends to health trusts, councils, emergency services, the voluntary sector, housing associations, government departments and large private companies who use sub-contractors including Alfred McAlpine, Royal Mail Group and British Aerospace.

Contractor Advice


For Free Contractor Advice on all tax and accounting issues please call PayMatters LTD on 0800 121 6513. For customer service for existing clients, please call 0844 335 0169.