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Feature

Sheltering under an Umbrella?

Posted on: 31 Jul 06

Summary

The Treasury is aware of a growing trend, which has recently moved into the pharmaceutical sector, for staff to be provided to clients through “umbrella” or “composite” companies. These companies promise a golden scenario of reduced costs to their clients and greater take-home pay to the individuals who work through them.

Sheltering under an Umbrella?

Hidden in the detailed materials published by the Treasury at the time of this year’s Budget was the following (paragraph references are to the Budget Red Book)
“5.85 Since the Pre-Budget Report, further evidence has emerged that employment income is being disguised as dividends in order to take advantage of the small companies’ tax rate, often encouraged by promoters of mass-marketed managed service company schemes. There is also evidence of some agencies, contractors and employers requiring workers to use corporate structures, thereby denying them employment rights as well as avoiding paying their fair share of tax and NICs.
5.86 The Government believes that all individuals and businesses must pay their fair share of NICs and tax, irrespective of legal form. It will continue to review the tax and NICs systems to ensure that this is the case and will bring forward proposals for discussion that are consistent with simplicity for compliant businesses, support for businesses in their aspirations to grow and maintaining the attractiveness of the UK as a business location. As the first stage of this review the Government will consult on action to tackle disguised employment through managed service company schemes.”

What this means is that the Treasury is aware of a growing trend, which has recently moved into the pharmaceutical sector, for staff to be provided to clients through “umbrella” or “composite” companies. These companies promise a golden scenario of reduced costs to their clients and greater take-home pay to the individuals who work through them.

Sounds too good to be true? Well yes – and guess what, in most cases it is too good to be true.

The magic ingredient in their formula is what can politely be called aggressive tax planning – pay is passed down to contractors through limited companies in a way designed to minimise the tax and national insurance payable.

Fair game? Well tax avoidance is said to be the national sport of Italy and why should they have all the fun?

The risk that individuals who decide to go through this route face is as follows – it is all very well for such umbrella companies to claim that their methods are above board and even “approved” by HM Revenue & Customs, but all the evidence suggests that the “umbrella” proposition is riding for a fall.

What could go wrong with this golden scenario of low tax and more pay?

The key issue is that the “umbrella” proposition is driven by a clever paper trail of documentation designed to avoid paying tax and national insurance. The key risk is that the taxman is ultimately going to be persuaded by the substance of the arrangements, not by the legal/contractual form.

There are clear definitions of the factors that determine whether an individual should be classed as an employee on the HMRC website – these reflect the law of the land as established both by Parliament and actual tax cases that HMRC have brought against individuals they suspect of being “disguised employees.”  http://www.hmrc.gov.uk/pdfs/ir56.htm

When HMRC look at your arrangements, which could happen from a routine inspection of the tax affairs of the end-client or of the umbrella/composite company, the criteria in IR56 will be used to judge whether you should be treated as an employee.  The fact that you have a contract that says you are self-employed and a clean paper trail will not protect you if the way you work meets the test of employment.

Does that mean it is impossible to be self-employed? Not at all – if the way you work genuinely meets the tests laid down in IR56 you can quite legitimately obtain the benefits of the favourable tax regimes available to the self-employed.

Does this apply to everyone who works on contract in the pharmaceutical sector? No – the majority of insourced workers in the pharmaceutical sector are still provided through companies, such as PDR Partners, that ensure that neither their staff nor their customers are put at risk because they offer all staff a proper contract of employment, providing continuity of employment, the benefits of employment such as holidays, pensions etc. and crucially they pay over the appropriate tax and national insurance so you need not fear the brown envelope from the taxman on your doormat.

What if I get caught?  If you have been working for any period of time as a contractor either directly or through an umbrella/composite, but the substance of the way you work would not support your claim to be self-employed, then your risk is three-fold:

-          you could be compelled to pay back-taxes and national insurance on any amounts that HMRC assessed should have been taxed as employment income;

-          you would be charged interest on the fact that these payments had not been made when they should have been made – i.e. in the month you earned them

-          you could be subject to penalties depending on HMRC’s assessment of the reasons for your failure to pay the proper tax and national insurance.

But I have a guarantee from my umbrella/composite company that says they will pay any tax that I am charged, don’t I? Different companies make different claims for the protection they offer their staff – however, the reality is stark. Consider the example of an umbrella/composite company with 100 staff, each of whom was assessed as owing £20,000 in back tax and national insurance. It is of course possible that the company would have both the means and the will to write out cheques for £2 million to compensate all the staff. It is not beyond the bounds of possibility however that the company quietly goes bust, leaving all its staff to pick up the bill. And if that were to happen its current staff could well lose money they were owed for their last month’s pay as well.

But will it really happen? It is easy for umbrella/composite companies to say “we’ve been doing this for years and haven’t got into trouble yet” and that may be true. However the law, as set out in IR56 remains the law. What the Budget statement shows is that – as more and more umbrella-type companies have been setting themselves up in different industries, including now the pharmaceutical sector – this has become an issue right in the forefront of Gordon Brown’s view.  In July 2006 the HMRC started a high profile case against a major provider of contract staff in the construction sector and it is likely that more such cases will follow.

What should I do? Look at the criteria set out in IR56 and ask yourself the question – “do I really think that the way I work makes me meet the tests to be self-employed?” If so, fine.  If not, then you should consider whether it might not be in your best interests to review your working arrangements.

 

Claire Jackaman, Managing Director, PDR Partners

It may be useful to review the following articles:
Contractors Face Uncertainty as Gabem Tax Ruling Ends
This is a review of the recent case involving Gabem, a composite services company. It was written by Brian Gorman and appeared in The Recruiter magazine of 26th July 2006.
Umbrella and Composite Companies and Why You Shouldn't Use Them
This is a review of umbrella companies and composite companies from a different industry's viewpoint

Claire Jackaman

Last updated on: 27/08/2010 11:40:18

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