In recent days, HM Revenue & Customs (HMRC) has issued a warning to contractors that signing up to umbrella schemes which appear to be ‘too good to be true’ could lead to problems later down the line.

In a new guidance document entitled Umbrella companies offering to increase your take home pay (Spotlight 45), the Revenue warns contractors to watch out for dubious schemes which claim that contractors can increase their take home pay by anywhere between 80 and 95 per cent.

Specifically, it has warned that many such schemes are making ‘misleading’ claims with regards to the financial benefits offered under such schemes being ‘legitimate’ or ‘tax-efficient’ when, in actuality, contractors that use these schemes are likely to end up paying much more in tax later down the line. This is because HMRC will always move to challenge perceived tax avoidance schemes.

How do these dubious schemes work?

Umbrella schemes offering high pay retention will vary, but these schemes tend to have a number of things in common – most notably that they will promise that contractors will be able to retain a greater slice of their income while simultaneously reducing their paperwork burden.

In most case, a large part of the remuneration received by contractors using these schemes will be transferred as a loan, or via credit. Promoters of the schemes will often claim that these means are ‘non-taxable’, but in reality, HMRC is likely to treat such payments in a very similar way to normal income – meaning that tax and National Insurance Contributions (NIC) will most likely be payable.

What’s more, such payments will often be transferred through a chain of several companies before the freelancer themselves actually receives the money.

Contractors have been warned that umbrella schemes will often require them to sign up for these potentially troublesome arrangements from the outset. In instances where this is the case, freelancers should never accept this at face value and should always seek specialist advice at the earliest possible opportunity before getting themselves into something which might prove costly and problematic later down the line, as has been the case with many people who have been duped into using such schemes.