Inside IR35 - the Risks

Working inside IR35 requires a third party to collect the rate from your client, deduct tax and pay it to HMRC, deduct anything else and then pay you the net (and maybe some expenses).

The use of a third party that you have little control over, and that only exists to perform a financial service for you presents some commercial risks that are not present in ordinary PAYE employment or Limited company contracting (ie. outside IR35). The payer (the client you work for) has no commercial relationship with the umbrella (at least, not in the scope of your work and pay etc). Some umbrellas may have referral deals with recruiters, agencies or your end clients (you can ask them about this, if you want). These arrangements may bind companies together contractually, but that contract does not extend to helping you out in any way, should you need any help. See About Umbrellas for a little more on this subject.

As the contractor you must pay the umbrella fees, which makes you a customer, and you'll have a contract with the umbrella. In fact, you're actually an employee of the umbrella, so they'll be holding back a small amount of your pay to provide you with holiday/sick pay (you should check how you'll get paid this if you don't go on holiday during the contract!). Ultimately though, the chain of companies involved, some of whom you have a contract with, and some you don't makes the commercial arrangements more complicated than they may appear.

Aside from the "middle man" issues, inside IR35 work is like any other type of contracting. There are no employment protections, and you can be terminated with immediate effect without reason, or just simply not given any further work at any time. It's also possible your client may (for a variety of reasons) not pay your rate to the umbrella or agency, which will result in problems getting paid for your work.

As with any contracting, you'll probably be required to submit a timesheet and account for the time you've spent on tasks. This forms the basis of what you'll get paid, and is usually approved by someone at your client before any money is actually paid. As with any contracting, delays, disputes or refusal to approve a timesheet can cause problems getting paid.

Fraud (or "tax avoidance")

The most scary risk to inside IR35 working is the chance of fraud in the umbrella or agency. Despite HMRC protestations to the contrary, there are numerous companies actively selling "tax avoidance" schemes which promise to reduce the tax inside IR35 workers pay. However, what they actually do is defraud HMRC and leave the worker with the tax bill. HMRC seem unwilling or unable to deal with this problem effectively, and so the practice continues.

These "dodgy" umbrella companies typically entice new workers to use them with the promise of lower tax bills. However, it is a mistake to think that because an umbrella doesn't offer this that it "safe". In fact, it is possible that an umbrella can look like it's paying all the right taxes, but in fact be leaving the worker in a worse situation because it hasn't paid them as much as the "tax avoidance" scheme operators would have done.

Further, an umbrella company may be completely legitimate and fully legal, have years of honest and reliable trading history, have correctly paid tax for months of a workers contract and still become fraudulent at a later date. The longer the fraud goes undetected by the worker, the bigger the subsequent bill from HMRC will become - and remember, HMRC can look back several years to present demands for past non-payments.

Ultimately, if an umbrella fails to pay tax to HMRC, then that money is still owed to them by the worker (NOT the umbrella!). Workers using umbrellas have been unwittingly involved in fraud and have been presented with life-changing bills from HMRC as a result. Fighting off such a demand, or even getting time to pay it, is a long, expensive and personally demanding experience - far better avoided if at all possible.

There is no way to guarantee that a given umbrella will never commit fraud. Using a reputable company seems like an easy enough proposition, but figuring out who is "reputable" and who isn't can be tricky and time consuming. Trusting online reviews, or even the recommendation of a friend or client is also not a reliable way to ensure the umbrella is actually reliable.

We describe how to check in to an umbrella or agency to determine how reputable they are in Payer Due Diligence. Even this is no guarantee of success though, so working inside IR35 carries a continuous risk that all workers should be aware of and mitigate as far as possible.

Umbrella Scams

Various scams are on the rise in unscrupulous umbrella companies. These include simple things like withholding holiday pay (by either just not paying it or by adding conditions such as any not claimed within a certain time is forfeit). More complex scams include adding some fake expenses to the bill passed up to the client, or by skimming money off the contractor and simply hiding it on the payslip by not doing the adding up correctly on it.

InniAccounts published a good guide into some of the common scams at umbrella companies: Umbrella Companies: Common Skims, Scams and Unethical Practices

Changes at an Umbrella

It is possible that a contractor may choose an umbrella company, perform all the necessary due-diligence and begin working very successfully through it. However, at some future time, the umbrella company may decide (and is at liberty) to sell that contractor's contract to another organisation. This would then mean that the contractor would (without necessarily their specific knowledge or consent) be working through an entirely different umbrella company. This new company may not be reputable, and may commit fraud with the contractors money, leaving the contractor liable. The only indications this may have happened may be in the "small print" on a payslip or similar.

This and other risks can only be mitigated with continuous vigilance and to check and double-check the details of the operations of the umbrella company.

Umbrella Company Goes Bust

All umbrella companies work on pretty tight margins - that means they don't have large amounts of money sloshing about in them to be able to weather any ups and downs in their trading.

There have been cases of umbrella companies going bust, leaving contractors without their pay. In at least one case, the umbrella hadn't been paying HMRC (presumably to try to help their cashflow) - and as HMRC have "preferential status", when the administrators took the company over, HMRC will have got their money before any contractors would have seen any of theirs.

Also see: The Story of Unified Payroll

Moving from Outside IR35 to Inside

Any role that moves from outside IR35 to inside presents a tax risk to the contractor. This is especially true when crossing the April 2021 implementation date.

The problem with moving from outside to inside is that HMRC will view the previous outside work as (probably) being inside all along (despite what any determination may have stated). If they successfully argue this point, then all the previous fees from the outside part of the work suddenly become liable for "inside" taxes - and that could leave the contractor with a big tax bill (and very little time to pay it). They probably won't take all Corporation Tax, VAT etc that's already been paid into account when working out what you owe - so if you end up down this path, it can be very, very costly.

As a general rule, if a role moves from outside to inside, the contractor should consider continuing to work very carefully. The safest course of action is to terminate the arrangement and find another job somewhere else. Where this is not possible, then some very careful documentation of the reason for the change in status would be very advisable. You may also want to consult with professional experts to work out the best way to insulate yourself from future problems.