Banks clampdown on loophole that allows contractors to pay just 10% tax

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Some might say that banks have been slow to clampdown, but offshore umbrella companies – still used by hundreds of contractors in the City to allow them to take home up to 90% of their income – are set to go the way of the dinosaur.

Banks with armies of contractors in the City including Lloyds, Barclays and Royal Bank of Scotland have told recruiters in recent weeks to close the loophole that allows temporary employees still operating under an offshore umbrella companies in order to avoid huge amounts of income tax. This still amounts to hundreds of people, largely long-term contractors at one organisation who may have been able to slip through new rules clamping down on the practice, suggest recruiters.

In October last year, HMRC updated legislation that sought to eliminate offshore umbrella companies which help contractors avoid income tax and national insurance contributions. Effectively it meant that contractors would receive payment direct from recruitment agencies who work with the end client. They become responsible for deducting tax and NI, so the benefit of using these umbrella companies is lost.

It’s been slow to take full effect, and banks are only now telling recruitment agencies to get their houses in order and ensure that contractors can no longer use offshore umbrella companies. “Banks are telling us to ensure that all our contractors are compliant, and this affects a lot of people across the City,” says one recruiter who declined to be named. “A lot of people have been using these companies for years, so it will drastically impact their take home pay.”

Contractors are still free to use UK-based umbrella companies like Parasol or Giant, which take the headache out of tax calculations but offer nothing like the tax breaks of the offshore firms. Most contractors in the City earning over £500 a day usually set themselves up as limited companies anyway, suggest recruiters, which is still viewed as the most tax-efficient way of working.

Contractors have typically been among the most active in seeking out ways to comply with the spirit, rather than the letter, of the law when it comes to income tax payments. However, the UK government’s Targeted Anti Avoidance Rules (TAAR), within the Onshore Intermediaries legislation coming into effect this month, is aimed at ensuring all possible loopholes are closed.

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