If your end client decides to use a PAYE model, e.g. perm, umbrella or agency payroll, how much should you increase your daily rate by?
This is a complex question that depends on many variables, consequently, in reality, a particular % increase will not necessarily apply to all contractors.
I will give an example of what rate increase an average single person limited company contractor will require (however this may not apply to your individual circumstances).
Assuming a contractor works 230 days per year (a big assumption given that I have seen contractors be out of work for months at a time) on £400/day plus VAT then that contractor’s limited company will earn around 230 days x £400/day = £92,000 + VAT.
For the purposes of simplicity, I will ignore VAT as contractors usually just act as VAT agents, i.e. the VAT they receive will pretty much all be paid out to HMRC VAT.
Based on £92k of income and £15k of business expenses (e.g. a £8k tax efficient salary, £2k of travel, £2k of subsistence, £2k of other expenses, and £1k on accountancy and insurance) this will create £77k of net profit and a £15k corporation tax bill (which is the result of a 19% corporation tax rate on the £77k of net profit).
The remaining £62k (i.e. net profit minus corporation tax) can be taken out as dividends if the contract(s) is outside of IR35.
Many contractors take out around £42k of dividends only (despite having the potential to take out more dividends) in order to avoid the 32.5% higher rate tax on dividends.
The £20k surplus that they leave in the company will eventually get taxed at 10% (provided all the conditions for entrepreneur’s relief are met) when the contractor ceases to trade and liquidates their company.
The £42k of dividends paid will generally be taxed at 7.5% which would create an additional circa £3k of income tax when the contractor completes their self-assessment tax return.
Therefore the contractor and/or their company loses around £1k in accountancy/insurance, £15k in corporation tax, £3k in dividends/income tax, and eventually £2k in capital gains tax should they meet the conditions for entrepreneur’s relief = a total loss of circa £21k. Therefore this leaves a retention of £92k – £21k = £71k (i.e. a 77% retention).
On a £110k PAYE salary your retention/net pay will generally be around £71k (65% retention). Based on the same 230 days mentioned above the equivalent PAYE daily rate in order to maintain a £71k retention would be £110k/230 days = £480. This £480/day rate represents a 20% increase in daily rate on the £400/day rate outside IR35.
Please note that this £480 daily rate includes holiday pay rolled up into it. In other words, the recruitment agency may only pay you around £420/day (i.e. £60/day less than the £480/day that you negotiate) but then pay you when you take annual leave from the £60/day that they have been storing up for you.
Therefore, when speaking to recruitment agencies regarding umbrella/agency roles make sure you understand whether the rate includes things like holiday pay and employer’s NI or if the rate is excluding holiday pay and employer’s NI and therefore these things will be paid on top.
Ask your agency for a key information document (KID) and study this carefully. Rather than buyer beware, it is more like a case of seller beware!
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The above information is just for guidance purposes only and is not a substitute for professional advice and consulting the legislation.