PAYE vs Sole Trader: Which is Better After IR35?

IR35 has long been the cause of confusion, frustration and increased workloads for contractors and companies employing them. Following the legislation update in April 2021, more than one in three contractors have left self-employment altogether, with most moving into permanent employment and others working overseas. Some are unable to work at all and others have chosen to take a career break.

The UK contractors still working in non-permanent roles represent an almost even split between classification as inside IR35 and outside IR35. However, one half is happier than the other: 80% of temporary workers now operating inside IR35 have seen a significant drop in their earnings. Generate’s payroll and contractor management specialists reveal the benefits and considerations for each working model for 2022 and beyond.

The Benefits and Drawbacks of PAYE and Sole Trader Status

Reasons to Work through PAYE

Security – As a contractor, you effectively become an employee of an umbrella or contractor management company, guaranteeing regular on-time payment in full. This option ensures you are fully compliant, wherever and whenever you work, and depending on your provider you can be covered by comprehensive insurance.

Reduced Workload – The simplest solution for most temporary workers, this option means you receive a fixed salary as agreed with the agency on a weekly or monthly basis. All taxes and national insurance deductions will be organised and paid on your behalf, dramatically reducing your admin burden and freeing up more time to concentrate on your assignment.

Benefits – As an employee of your umbrella or contractor management company, you will be entitled to all the same benefits as a permanent staff member. This includes paid annual leave, statutory sick pay, statutory maternity or paternity pay, and potentially even the private healthcare, childcare and expenses benefits of your permanent colleagues. Some contractor management companies even offer addition benefits such as discounts on CPD and diploma courses, to help with your professional development whilst you work.

Find out more about Generate’s PAYE services.

Considerations and Drawbacks of PAYE

Limited Options – PAYE is only available through one recruitment agency and one end client, meaning it’s therefore likely to best suit those on medium- to long-term assignments. You can commit to multiple assignments for multiple vendors simultaneously, although this means additional contracts under your payroll/umbrella provider for each one, increasing admin and costs.

Cost – Umbrella Companies and payroll providers will charge a fee to cover their own services, and this can vary between different providers. You will also need to pay both your own National Insurance contributions and those of the end client, meaning a reduction in take-home pay. However, this cost is significantly smaller than the fines imposed for non-compliance, and offsets the personal cost of doing your own administration.

Lack of Flexibility and Autonomy – Involving other parties means the possibility of delays in communication, timesheets and ultimately payment if your provider is not up to task. Find out what makes a compliant, trustworthy payroll provider.

Reasons to Be a Sole Trader

Income – Sole traders are not automatically inside IR35, and are only affected by the legislation update if they fulfil specific criteria including those around mutuality of obligation, relationship of authority and supervision with your end client and using your own tools and equipment. This contracting option allows workers to keep their fixed overheads low, and without an incorporated business you don’t need to pay Corporation Tax or submit annual accounts.

Flexibility – Without the need to register as a legal entity or go through paperwork with agency providers before you take on an assignment, you can start working and earning straight away. Registering as self-employed for tax purposes is usually quick and easy. At any point down the line, you can change your business structure to a limited company to become more tax-efficient, or adapt to other employment options if you choose.

Career Development – As a sole trader you can work through multiple agencies and on multiple different projects at one time. This also means you get the expert advice of each different umbrella or contractor management company. The ability to take on multiple assignments easily and quickly means a greater variety of work and learning opportunities for professional development.

Drawbacks of Being a Sole Trader

Compliance Risk – Taking sole responsibility for your taxes is increasingly riskier following the off-payroll legislation update. The lack of specific details and largely untested results of IR35 are likely to mean growing volumes of court cases in the coming years. Although only around 30 off-payroll cases have ever reached court decisions, wins are so far split almost equally between contractors and HMRC, meaning a 50/50 chance of large fines for contesting non-compliance. In July 2021, HMRC won another court case against a project manager, ruling that he would have been an employee if he were engaged directly, and he was therefore found to be inside IR35. As the Government’s official status determination tool returns inaccurate results for 1 in 7 contractors, sole traders face increasing difficulties to remain compliant with the law.

Admin Burden – The administrative burden of doing your own accounting, especially for those who are new to the task, is daunting and time-consuming. Keeping on top of your finances is often a distraction from your day job, with the added stress outweighing the potential benefits. Taxes can be much more efficient when working as a limited company or under PAYE.