IR35, One Foreign Client, Is Sole Trader Better?

[WordIsBond]

I really have looked for answers here but my situation is weird enough that it doesn't really seem to have been addressed.

I've worked for years as an employee of a foreign (non-EU) company while living here in the UK. We operated PAYE voluntarily for me and a relative who was also employed. At the company's suggestion, to address a domestic regulatory concern, I am now contracting rather than employed, and employing my relative. We are very niche. We may find it hard to find other contracts, and they will certainly find it very hard to replace us and aren't looking.

So, one client, our former employer. We left on a Friday (3/4) and started consulting on a Monday (6/4), were under PAYE, etc, all the red flags that HMRC doesn't like. But we're on a fixed project, no control, a very IR35 friendly contract, the company is highly motivated to protect our independence, etc. I think we'd escape IR35 but there is some real risk.

I read that you can't get clients as a sole trader, but in this case, the company doesn't care because, as a foreign company, HMRC would have a hard time sticking them for employment taxes. So I've signed our first contract as a sole trader.

My thinking was that if I form a limited company, I'm vulnerable to IR35, which costs the company nothing and costs me plenty. And if I stay a sole trader, the company is vulnerable to being ruled my employer, which costs me virtually nothing and also, in this case, costs them nothing. And I save annual reports, etc, of the limited company.

Further to this, I have dual citizenship (America) so have to file US taxes, and the US taxation treatment of dividends is NOT as favorable as here (what the Brits give the Americans take, and vice versa ), and the reporting requirement for owners of foreign corporations is very onerous. So some of the tax benefit of a limited company would be lost in American taxes, I think. So then I start to wonder, between the IR35 risk and the American tax situation, if it is worth it.

Am I missing something?

[TheFaQQer]

Am I missing something?

The legal protection that operating via a company with limited liability offers you.

[WordIsBond]

The legal protection that operating via a company with limited liability offers you.

Ah, thank you. I suppose PI insurance helps with that, but only to an extent. My liability exposure is quite limited (I just won't be doing anything that is likely to make me a target), but even so, that protection could be important.

[jamesbrown]

Aside from the question of limited liability, the other thing to bear in mind is that self-employment doesn't avoid HMRC being interested in the relationship. While IR35 is the specific legislation designed to target "disguised' employment via a Ltd company, there is similar legislation to prevent disguised employment as a sole trader. The main difference is where the liabilities rest, with IR35 being a company liability (unless they can transfer it to the director through negligence). I'm not sure about the rules surrounding transfer of responsibilities for a self-employed person that is deemed employed for tax purposes when the "client" is overseas; the risk may transfer to you, or it may rest with your "client" (either way, it isn't good).

So, the question of whether you're effectively an employee is going to arise either way. Of course, you could decide to operate via a Ltd and apply IR35 as caught on that particular contract (essentially 95% through PAYE). No problems with the latter, and you seem to have been doing this so far. Bear in mind, though, that this will entail additional costs that your overseas employer may have been paying to date, i.e. you may need to renegotiate your rate to break even in the new scenario.

[WordIsBond]

James, thank you for the response.

I'm not sure about the rules surrounding transfer of responsibilities for a self-employed person that is deemed employed for tax purposes when the "client" is overseas; the risk may transfer to you, or it may rest with your "client" (either way, it isn't good).

Just as I think we'd probably beat the rap on IR35, I think we would probably win this, too. A lot of things changed in the transition. But there is risk.

As best I can see, there is no provision for an employee being held liable for employer NICs. The worst that could happen for me, I think, is being held responsible for the difference between Class 1 NIC and (Class 2 + Class 4). And my client has no presence here that HMRC could go after.

Of course, you could decide to operate via a Ltd and apply IR35 as caught on that particular contract (essentially 95% through PAYE). No problems with the latter, and you seem to have been doing this so far. Bear in mind, though, that this will entail additional costs that your overseas employer may have been paying to date, i.e. you may need to renegotiate your rate to break even in the new scenario.

No concerns about breaking even. They really are treating me as a contractor -- I'll clear a lot more income than before, however I do this.

If I think I could beat IR35, though, I'm not inclined to just surrender without a fight on the chance that I'd lose. I might walk away from the fight (go sole trader) if there's a risk, but just concede and pay taxes I don't think I should be paying? I'd have to consider the risk pretty high to do that.

I wonder if QDOS would offer their Tax Liability Cover to someone with my profile. Wouldn't be ethical to buy without full disclosure, of course. But we've got a good contract and it is a real one. It is those red flags that are scaring me, not the actual contract and working relationship.

Thanks again.

[jamesbrown]

James, thank you for the response.

Just as I think we'd probably beat the rap on IR35, I think we would probably win this, too. A lot of things changed in the transition. But there is risk.

As best I can see, there is no provision for an employee being held liable for employer NICs. The worst that could happen for me, I think, is being held responsible for the difference between Class 1 NIC and (Class 2 + Class 4). And my client has no presence here that HMRC could go after.


No concerns about breaking even. They really are treating me as a contractor -- I'll clear a lot more income than before, however I do this.

If I think I could beat IR35, though, I'm not inclined to just surrender without a fight on the chance that I'd lose. I might walk away from the fight (go sole trader) if there's a risk, but just concede and pay taxes I don't think I should be paying? I'd have to consider the risk pretty high to do that.

I wonder if QDOS would offer their Tax Liability Cover to someone with my profile. Wouldn't be ethical to buy without full disclosure, of course. But we've got a good contract and it is a real one. It is those red flags that are scaring me, not the actual contract and working relationship.

Thanks again.

To a large extent, you should separate the decision about whether to go Ltd from any tax-related issues, because you can operate as IR35 caught on a contract-by-contract basis and any tax-benefits of a Ltd company are arguably secondary (but there are also some costs). Then, in terms of IR35, you could well be in a strong position in terms of lack of D&C, lack of MoO and an unfettered RoS, but the superficial facts will count against you, based on what you've said. By all means, have any contract and working practices reviewed and follow that advice (rather than listening to speculation here). I doubt QDoS would offer you cover as I believe they specifically ask that question w/r to working for a previous employer, but soliciting a review (where you fully explain your position) would be the first step.

Of course, if you do receive dividend income instead of PAYE, you'll have other issues w/r to US taxes, as you mention in the OP (e.g. the Foreign Earned Income Exclusion only applies to earned income). Incidentally, as was pointed out here recently, if you have a simple set-up, you may be able to establish YourCo as a "disregarded entity" for the purposes of IRS filing, which will simplify the corporate side of things, but you'll still need to file a personal return (with some extra forms), alongside dealing with your UK taxes.

[WordIsBond]

To a large extent, you should separate the decision about whether to go Ltd from any tax-related issues

This, I think, is very good advice.

I doubt QDoS would offer you cover as I believe they specifically ask that question w/r to working for a previous employer, but soliciting a review (where you fully explain your position) would be the first step.

I'll pursue that, thank you.

Of course, if you do receive dividend income instead of PAYE, you'll have other issues w/r to US taxes, as you mention in the OP (e.g. the Foreign Earned Income Exclusion only applies to earned income). Incidentally, as was pointed out here recently, if you have a simple set-up, you may be able to establish YourCo as a "disregarded entity" for the purposes of IRS filing, which will simplify the corporate side of things, but you'll still need to file a personal return (with some extra forms), alongside dealing with your UK taxes.

I've never used the exclusion, I always used Foreign Tax Credit, and I have a huge carryover of unused credit. This would be dividends from a CFC, which are general category for the FTC, which means my carried-over credit would apply (just checked). So the US tax might not be so bad except for the filing requirements. I'll check out the "disregarded entity" thing, that one is news to me.

Thanks again for all your help.

(By the way, generally US people in the UK who have children should almost always use the Foreign Tax Credit rather than the income exclusion. A helpful IRS man at the embassy explained it to me -- if you use the FTC you can get the additional child credit of $1K per year per child. That's not contractor related, but I'll drop it here anyway in case it helps someone sometime.)

[jamesbrown]

I've never used the exclusion, I always used Foreign Tax Credit, and I have a huge carryover of unused credit. This would be dividends from a CFC, which are general category for the FTC, which means my carried-over credit would apply (just checked). So the US tax might not be so bad except for the filing requirements. I'll check out the "disregarded entity" thing, that one is news to me.

Interesting - good to know. The election to be a disregarded entity is made on form 8832, which has some explanation in the notes. However, this is not the sort of election you'd want to make without professional advice.

Some useful background here. Notably:

"Disregarded entity. If the LLC is owned by just one distinct Member, such as yourself, it can avoid
classification as a foreign corporation by electing to be a “disregarded entity.” In that case, the LLC
doesn’t file an income tax return; instead, as the Member who owns the entire company, you would
include all of the company’s income, deductions and credits on your own tax return. It’s as though the
company is simply a financial account that you own."

[WordIsBond]

However, this is not the sort of election you'd want to make without professional advice.

You can say that again.

"Disregarded entity. If the LLC is owned by just one distinct Member, such as yourself, it can avoid
classification as a foreign corporation by electing to be a “disregarded entity.” In that case, the LLC
doesn’t file an income tax return; instead, as the Member who owns the entire company, you would
include all of the company’s income, deductions and credits on your own tax return. It’s as though the
company is simply a financial account that you own."

This may mean shares for my wife or another family member would be a bad idea. Or maybe not, given the complicated ownership rules -- we might be deemed one shareholder under US rules. I just read it would be treated as Schedule C (self-employment). Which would mean we're back to general category income for foreign tax credit, and also eligible for the exclusion if someone went that route. In any event, it sounds like Form 5471 would be avoidable, which is obviously desirable.

Which is all an extended way of saying what you said -- get professional advice. What a minefield. No wonder some U.S. citizens abroad renounce their citizenship. Between the taxes due and the advice and the time lost, it is going to cost me thousands, most of which will not benefit the US Government in any way.