The Fizz! Blog

How does Maternity Pay work for freelancers?

If you’re a sole trader you don’t qualify for Statutory Maternity Pay - that’s only payable to employees. However, there are two bits of good news:

1. You’re very likely to get Maternity Allowance instead. That’s the State Benefit for those who don’t qualify for SMP. Most freelancers will get it at a similar rate to SMP.
2. Unlike SMP, Maternity Allowance isn’t taxable! So someone getting that standard rate of Maternity Allowance will probably be better off than someone getting the same amount of SMP.

The downside is that, unlike an employee, you don’t get 90% of your usual income for the first six weeks - you just get the standard rate throughout. You’re likely to be a little worse off in that respect - but the tax saving will compensate anyway.

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How does Statutory Maternity Pay work for company directors?

Company directors are entitled to SMP on the exact same basis as any other employee - assuming they were on the payroll at the right time, then they’re entitled to 90% of their normal pay for six weeks, and then at a standard level for the next 33. In practice, the company carries on paying the director’s salary as usual, but HMRC reimburses the company for the majority. But, although the rules are just the normal rules, the different circumstances they’re being applied to leads to some wrinkles:

• More often than not (for sensible tax-planning purposes) a director will be paid a pretty low salary compared to other employees. That means that the first six weeks at 90% of normal pay aren’t actually that exciting.
• SMP is only payable whilst you’re still on maternity leave. Business owners tend to come back to the business rather more quickly than the typical employee (particularly if they themselves are the entire workforce!). After 10 “keeping in touch” days, SMP is no longer payable, and that can happen fairly early on for an owner-director.
• Usually HMRC reimburses an employer for SMP by knocking it off the monthly PAYE payments the employer makes to them. But if the director is the only employee, there might be no such monthly PAYE payments. In that case, by default HMRC will reimburse the company after the end of each tax year, but that could cause cashflow issues in the meantime. If so, it’s possible for the employer to ask HMRC to give it the cash up front, to be dripped out to the director as SMP over the period of leave.  That system actually works quite well. Be careful though - if the director comes back to work earlier than anticipated, the company will have to return some of that up front payment to HMRC, and in the meantime the extra lump of money in the company bank account hasn’t really given you any more money to pay dividends or any other costs - else, it’s sitting there to subside the salary over the period of leave.

In general, everything about the system works well - as long as you let your accountant know when you’re going on leave and when you return, anyway!

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Are you getting all the tax relief you can on your workplace pension contributions?

Automatic Enrolment pension schemes have been with us for more than 10 years now. They’ve been a success. They represented a change from “you can contribute some of your salary to a pension if you want to, but you’ve got to set it up yourself” to “some of your PAYE earnings will automatically be contributed to a pension unless you take positive action to come out of it, and then keep taking that action every few years if you want to stay out of it”. It was thought that many people might come out, but plenty would stay in. In fact, the vast majority stayed in. The government tops up your own contribution AND your employer has to contribute too - generally, people have to be very short on income in order to be willing to sacrifice the free money.

There’s a complicating factor, which is that there are two mechanisms by which the schemes can operate (and all employers pick one and one only - you don’t see them giving employees a choice). There’s no difference in how the employer contributions work, but there is a difference in the tax relief on the employee’s own contributions:

• Relief at Source (RAS). In these schemes, for every £8 you contribute, HMRC add another £2. That means everyone gets 20% tax relief from the outset - £10 in their pot at the cost of £8. If your income is above £50,270, and you’re therefore paying tax at a rate above 20%, you can save more tax, but you have to do a bit of extra work to get it.
• Net Pay Arrangement (NPA). In these schemes, your contribution is knocked off your salary before the tax on your payslip is worked out. That means that the tax relief you get depends upon your income:

1. If your income for the year is going to be less than £12,570 anyway, you’ll get no tax relief at all! The tax on your payslips was going to be zero, it’s still zero.
2. If your income for the year is going to be between £12,570 and £50,270, then the reduction in your gross means that you save 20% tax on the contribution. Just the same as your friend in an RAS scheme.
3. If your income for the year is going to be over £50,270, then you’ll save tax via the tax deduction on your payslip at a higher rate - the exact rate depends on your income. The best case scenario is if your income would otherwise be between £100,000 and £125,140 - the reduction in your gross means that you save 60% tax on the contribution! You don’t need to do anything to get all the tax relief you’re due, it all happens on your payslip.

There’s one type of person who loses out permanently here. It’s NPA person #1. They get no tax relief at all! The lowest income people, if they’re in an NPA scheme, get the least government contribution to their pot. An employer who is likely to employ a bunch of people like this might lean towards an RAS scheme if they were kind.

A person who has income between £12,570 and £50,270 should be indifferent to which mechanism is in use. They save 20% either way.

A person who has income above £50,270 should be more or less indifferent between the mechanisms as they needn’t miss out anything - but if they’re in an RAS scheme they just have to put a little more effort in. If they have to do a tax return anyway, the work is minimal - keeping track of their contributions for a tax year and sticking the number in a box on the return. If they don’t have to do a tax return, it’s still not that much work. They don’t have to join the tax return system - they can just write to HMRC once a year to tell them about their contributions, or tell HMRC via their Personal Tax Account. HMRC will just get the employer to adjust their monthly PAYE deductions to get to the right overall result.

In reality, there are likely to be tens of thousands of people who should be doing this, but aren’t. If you’re a higher-rate taxpayer and you don’t know what kind of scheme you’re in, it’d be a good idea to find out! The most commonly used provider, NEST, is a RAS scheme - 20% relief at the time, but you’ve got to do the work yourself to get any further relief you’re due. The second most commonly used provider, The People’s Pension, offers employers a choice of either option at the setup stage, so it could be either! You’d be able to find out from your employer, or from your online account - or from an accountant or PAYE professional looking at your payslips! And if you’re actually in a salary sacrifice system - which is probably the third most common way of dealing with all this - then that’s effectively an NPA, so you’re getting all your relief up-front.

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I've been told my contract is inside IR35 - but what does that mean in practical terms?

Previously on IR35:

• The legislation informally known as IR35 was introduced 23 years ago.  It aimed to prevent those billing via a limited company whilst performing an employee-style role for a customer from benefiting from any of a limited company’s tax advantages; instead they were to pay full employment taxes.
• It didn’t work, because it was self-assessed, and turkeys rarely vote for Christmas.
• In 2017, as a result, the responsibility for making the call changed - if you worked for a public body, the public body would decide if IR35 applied.  If it did, full employment taxes would apply and you’d just be paid the net.
• In 2021 (having been postponed for one year due to COVID), this was extended to large customers - similarly, it became their call on IR35 and their risk if they decided not to account for employment taxes.

If you’re a contractor or freelancer working longish projects with big or public sector customers, it’s therefore quite likely you’ll encounter IR35 these days.  But, if a customer or agency tells you that a contract is inside IR35, what does this mean to you in practice?   This isn’t necessarily a simple question, as there are a number of routes that the customer may take, with the literal implementation of the IR35 rules being the least common by far:

1. They might just put you on PAYE.
2. They might pay you via an umbrella company (from your point of view, this is to all intents and purposes exactly the same as PAYE).
3. They just might actually implement the IR35 process - we don’t see it often, but we do see it occasionally.  If they do, then you’ll send them invoices from your limited company as normal, but they’ll pay the invoices net of tax and National Insurance relating to you personally.  This is obviously a very weird concept, and since all three routes are designed to get to the same split of the money between you and HMRC, the well-worn road of PAYE/umbrella generally looks much more appealing to all concerned.

If you get the choice, your accountant will thank you for picking #1 or #2!  We don’t need the hassle of #3 either.

Here are three practical points to be aware of:

1. Make sure you know whether a contract is inside or outside IR35 before you sign it!
2. Be aware that an inside IR35 contract will leave you with less money in your pocket than an outside IR35 one.  How much less?  That will vary depending on the bigger picture of your whole situation, but as a rule of thumb you might consider that you’d need a 25% day rate hike to stand still.
3. You should talk to your accountant at the outset of the new gig, not later on down the line - as well as the decision on whether to accept the contract, there will very likely be other actions to take too.  It might well be appropriate to pause salary or dividends from your own company whilst working on an inside IR35 contract, and that can’t legitimately be done retrospectively.

It’d be nice if everyone had a common understanding of what inside IR35 means, and the steps we’ll all take when that’s the case.  Until then, you’ll always need to press until you find out what’s actually going to happen in practical terms.

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Going on maternity leave? Think twice about opting out of your employer’s pension scheme

When someone's about to go on maternity leave, they'll quite often look at trying to temporarily cut all unnecessary overheads.  You might think that one sensible step would be to opt out of their employer's pension scheme for a while.  Cutting this particular overhead is probably a very bad idea though.

If your employer operates their Automatic Enrolment pension scheme on the most common basis, you’ll be making a contribution each month, and so will they.  Those contributions vary according to your income, and get capped if you’re earning more than £50,000 per annum.

If you go on maternity, your income drops, and so do your contributions.  In fact, after the first six weeks of leave, from which point your salary will probably just consist of basic Statutory Maternity Pay, they’re likely to drop to zero.

But, crucially, your employer’s contributions do NOT reduce at all.  They’re obliged to carry on paying into your pension pot at the level mandated by your normal salary!  Other non-salary benefits work on the same basis, too; they can’t take away your company car or withdraw your medical insurance, for example.

So, by opting out at the start of maternity, an employee could lose nine months of employer pension contributions, whilst saving herself virtually nothing.  A very easy trap to fall into!

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HMRC pushing back on early furlough claims

In Spring 2020, a company called Carlick Contract Furniture Ltd furloughed much of their workforce, and began claiming funds from HMRC under the Job Retention Scheme to cover the cost. As part of that process, they did something that a lot of other employers will have done. They included a couple of new employees, who had been taken on in February 2020, but hadn’t been paid that month - as is often the case with people who start late in the month, it was agreed that they’d just be paid for their February hours on their March payslip.

However, the JRS rules were actually unambiguous on this point. Although people were quite understandably wanting to stretch those rules in the interest of fairness, it was made quite clear that to come under the scheme, an employee had to have formed part of a formal payroll report to HMRC prior to 19 March 2020. For most monthly-paying employers, that meant the person had to have been paid at the end of February. It wasn’t enough to have been an employee, you had to have had salary actually reported to HMRC. This isn’t something that emerged later on - it was widely discussed on accounting and payroll forums and everyone advising on claims and making them knew or should have known about it.

HMRC picked up the point, and demanded Carlick repay the money. The First Tier Tribunal has ruled (whilst expressing some regret) that they’re within their rights to do so, despite the claim having been in the spirit of the rules. This is obviously very unfortunate for the employer, who hasn’t benefited from the money and was really being kind to the employees, who otherwise they’d have simply cut loose. But it was always clear that the claim was not permitted by the letter of the law, so if you made a similar claim you should expect there to be a good chance that HMRC will come and ask for the money back at some point, and that if they do then you’ll have to pay.

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It's party time! Tax at Christmas 2022

After a party-free 2020 and a party-light 2021 perhaps it's going to be a party hard 2022!  If you're hoping to get the party started, here's a reminder about the tax rules around work Christmas parties and gifts.

If an employer provides a Christmas party that's available to all of its staff (note that this really applies to PAYE employees, as opposed to, say, freelancers), where the cost is less than £150 per head, then it can reclaim all of the VAT and deduct the entire remaining cost from its profits before working out its tax bill - effectively, if a normal VAT-registered limited company holds its party at a normal VAT-registered venue, every £100 spent on the party ends up costing the company £67 in the long run, once they've got the VAT back and saved corporation tax on what's left.  Actually, those allowances apply to annual events, not specifically Christmas ones - so you could have, say, a summer barbecue *and* a Christmas party costing less than £150 a head in total and still reclaim all of the VAT and get tax relief on the balance.

If you want to give a Christmas gift to staff, then in practice HMRC consider a relatively small item like a turkey or a fairly normal bottle of wine to be trivial, and won't try to tax the employee on the value of the gift (as we've written before, sporadic gifts and benefits each valued at £50 or less are explicitly considered trivial by HMRC). Assuming there's VAT on the gift when you buy it, then once more the ultimate cost of £100 of staff gifts to a normal VAT-registered limited company employer will be £67. Anything more valuable the employees will have to pay tax on - and you'll have to pay National Insurance too.

If you give gifts to customers, then they'll only save you tax in full if:

• The total value of gifts in a year to the customer is less than £50,
• The gift has a clear advert for your business on it, and
• You can't eat, drink or smoke it!

If you want to give a customer, say, a bottle of whisky then that's still completely fine, and may well make great business sense! But a) you can only claim the VAT back on the gift if it costs less than £50 and b) you won't save corporation tax on it however much it costs. So a £49 bottle will cost a company £41 in the end (it can get the VAT back but can't save any corporation tax) and a £100 bottle will cost it £100 - it can't reclaim any VAT or reduce your corporation tax or income tax bill at all.

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Can my limited company pay for my counselling or therapy sessions?

As ever with these questions, the "can" is a red herring that tempts a literal but unhelpful answer.  Your company can pay for anything, the real question is whether there will be knock-on tax consequences that make it a bad idea.

In this case, perhaps surprisingly, there probably aren't any adverse consequences.  The rules, HMRC's guidance about them and HMRC's internal manuals are clear - an employer can pay for counselling for employees with no tax consequences for the employee, and though HMRC say the exemption is tightly drawn it actually covers a lot of areas.

Now, this exemption is plainly not intended for owner-managed businesses.  For a big employer, claiming that they're only providing the therapy because of their needs as an employer, and that long-term personal benefit to the employee may well be created as well but it's not the reason for their footing the bill, is a reasonable assertion.  If it's your own business, then that dividing line between employer and employee is not so clear.  But HMRC are pretty unambiguous about it, so if you’re comfortable that the counselling you’re contemplating falls within HMRC's guidance as tax-free, then you should feel confident going ahead.  Your company must provide the therapy, so should contract with the therapist itself - it's no good arranging it yourself and claiming the costs back if you want the setup to be robust.

If you're a sole trader or a partner in a partnership, then this doesn't apply; these are employment tax rules.  A sole trader or partner will probably find it difficult to impossible to sustain the argument that the cost is tax-deductible - it's have to be incurred wholly and exclusively for the purpose of their trade.

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Which umbrella company should I choose?

An umbrella company offers a simple service.

A business is going to pay an individual to do some work for it. The business judges that the individual’s role amounts to that of an employee, who should properly be paid via PAYE. The business doesn’t want the admin of doing that themselves. The umbrella company offers to employ the individual instead, and invoice the employer for the salary and the other associated employment costs (NI, pension).

Or, a business is going to pay an individual to do some work for it. The business, considering it to be an employment role but being unwilling to put the person on PAYE, tells the individual that they must invoice them via some other entity, most commonly a limited company set up by the individual themselves for that purpose. The individual can’t be bothered doing that, or knows that in the hands of her own company the income will fall under IR35 and be subject to full employment taxes anyway. Instead she decides to sign up with an umbrella company, who will receive the fees, operate PAYE on them, and pay her the net.

What’s in it for the umbrella company? A fee (most commonly suffered by the employee, even if the business insisted upon the arrangement, naturally!).

They’ve had a chequered history. You can see that in theory they’re simply a vessel to get fees from A to B, with the appropriate employment taxes paid. So they should all end up with more or less the same split of money between the worker and HMRC, with their commission being the only variable.

However, market forces meant that they began to compete with one another, to try and offer a bigger share of the split to the worker and less to HMRC. This was never achieved by legitimate means. A favourite trick was based on a wilful misunderstanding of the rules on something called dispensations. A dispensation was an arrangement with HMRC, where HMRC said - for example - “If you reimburse an employee for legitimately incurred and legitimately tax deductible travel costs of up to £30, don’t bother telling us about it, we don’t want to record it as both income and deduction for the individual, it’s a waste of time as it ends up at zero”. Then, regardless of whether any such costs were actually incurred or not (they weren’t) the umbrella company would include a tax deduction of £150 on every week’s payslip, with a consequential suppression of the tax deduction truly due.

Eventually, HMRC got wise to this. Those schemes were exposed and shut down. Any time you read anything promising you materially greater take-home pay than similar providers, it should always have been clear that this could not be achieved legitimately, but now - crossed fingers - we’re back to an acceptance that umbrella companies are machines that process the same inputs in the same way and should, consequently, churn out the same outputs.

A rather long-winded way of saying - it shouldn’t matter, they should all be pretty much the same!

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I’m about to hire someone - what are the additional costs I need to budget for?

Clients frequently ask how much they need to budget for additional employment costs (by which they generally mean National Insurance and pension contributions) above and beyond the gross salary they’re going to be paying an employee. When creating financial projections, we tend (depending on the purpose of the projections and the level of accuracy merited) to default to 10%. In real life, though, it does depend upon how your workforce is made up.

With your first employee, the best answer is often “very little - it needn’t inform any decision making”. That’s because, at present, the Employment Allowance means that almost all employers are excused from paying the first £4,000 of Employer’s National Insurance. If you make your first hire, and they’re paid £35,000, say - the NI is covered in full, nothing for you to pay on top. You’ll end up needing to operate a pension scheme in due course, but annual employer contributions will be less than £1,000 under a standard setup. There’s going to be a bit of cost in getting the payroll processed and the pension set up of course, and you’d be wise to pay someone to help you get the HR and contracts side of things set up properly, but the additional costs at this point shouldn’t really make any difference to a sensible business owner.

Once the Employment Allowance is used up, the costs are more meaningful. Because National Insurance only kicks in on income over £9,000, and pension contributions are generally only calculated on income over £6,000, for relatively low-paid part-time staff, additional costs are minimal - for someone on £10,000, NI and pension contributions add less than 3%. But if someone is on £20,000 the additional costs are about 10%. By the time they’re on £40,000 the additional costs are just under 14%. They don’t get any higher than that. So if you wanted a “worst case” number, go with 14%. But you can see how important the make-up of the workforce is, and why 10% is generally fine for projections.

None of this is intended to deter anyone from employing staff! The extra costs are a fact of life, and generally a robust and successful business will take them in its stride, and won’t try to play fast and loose with employment law and pretend that employees aren’t really employees in order to avoid them - if a business can’t be successful within the rules that’s generally a problem with the business, not the rules. At the same time, though, it’s a really smart thing to think about and budget for.

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