Rumours of the October Budget revealing increases to Capital Gains Tax (CGT) and Employer National Insurance could significantly squeeze the income of umbrella company contractors, impacting both their take-home pay and long-term financial planning.
Here we go into more detail on how these changes might negatively affect umbrella workers, even if it means their services could come into even higher demand.
Impact of increased Capital Gains Tax
Umbrella company contractors are often taxed as employees rather than being able to declare their income as capital gains, so the direct impact of a capital gains tax hike may not seem obvious at first. However, there are several indirect effects:
Investment income: Contractors who have investment portfolios outside of tax-protected accounts, such as ISAs (Individual Savings Accounts) or SIPPs (Self-Invested Personal Pensions), would be directly affected by higher CGT rates. If a contractor has significant savings in stocks or other assets, they could face higher tax liabilities when they sell those assets for a gain. This could discourage contractors from making investments that supplement their income or from selling investments when they need to, given the risk of increased tax burdens.
“It’s all very well saying that millionaire entrepreneurs could take a capital gains tax hike on the chin, but these are far from the only people who would be hit hard by this tax rise,” says Sarah Coles, head of personal finance, Hargreaves Lansdown
Coles says ordinary investors with assets outside a stocks and shares ISA could see their tax rate “double, which risks flooring them with a horrible tax bill or forcing them to change their behaviour – which could cause a whole host of other issues.”
Coles says hiking the headline capital gains tax rate could put people off investment altogether – and erect another barrier to entry for new investors.
She says, “It might also stop people from selling current assets, because they’re worried about the tax. This could force them to make decisions that ultimately leave them worse off.
“It’s no wonder that our research shows that among higher rate taxpayers, changes to capital gains tax are the fourth most pressing Budget worry – after income tax, pension taxes and inheritance tax. Some 7% are worried about the impact it could have on them.”
Savings for the future: Many contractors use personal investments as a means of saving for retirement or periods of lower contract availability. A rise in CGT could make this more costly, reducing the attractiveness of long-term investments outside tax-advantaged vehicles. Contractors might hesitate to sell assets, impacting their financial flexibility.
Barriers to wealth building: Similar to retail investors, contractors could be discouraged from building wealth through investments due to higher CGT, especially as their cash flow may be less stable than salaried employees. The added tax burden could slow their ability to generate wealth outside their main source of income.
Impact of increased Employers’ NICs
An increase in employers’ national insurance could have significant repercussions for umbrella company contractors, because umbrella companies act as the contractor’s employer, and these additional costs are often passed down to the contractor. Here’s how:
Decreased take-home pay: While contractors technically are treated as employees under the umbrella company structure, the umbrella company deducts employer NICs from the contractor’s gross pay. If employers’ national insurance rates were to rise, these companies could likely pass on the cost to contractors in the form of reduced gross income, thereby lowering their overall take-home pay.
Reduced contracting benefits: A higher NIC burden could also make umbrella companies less attractive to contractors. Since contractors already face deductions for both employee and employer NICs, any further increase in employer NICs could tip the balance, leading some contractors to reconsider the umbrella structure or push for changes in how their contracts are managed (e.g., renegotiating pay or moving to alternative structures like personal service companies (PSCs) if allowed).
Increased cost for clients: Clients may find that umbrella contractors become more expensive if the umbrella companies increase their rates to account for the higher NICs. This could lead to fewer contract opportunities, as clients might look to reduce costs by outsourcing elsewhere or hiring fewer contractors.
In a report by the Financial Times, David Lane, chief executive of pension provider TPT Retirement Solutions, said an employer paying 10 per cent into its staff pension schemes “could be looking at anything between a 1-2 per cent increase in their staff payroll bill” if NI was charged at a flat rate of 13.8 per cent.
Nimesh Shah, chief executive of accountancy firm Blick Rothenberg, said in the same report that levying a NI rate of 13.8 per cent on employer pension contributions would negatively affect hiring decisions and business investment.
Rebecca Seeley Harris, founder of ReLegal Consulting, agreed, saying in the article that the moves would make recruitment “even harder”, leaving companies to react by not hiring altogether or opting to hire contractors but through umbrella companies. In essence, that would be the silver lining for contractors, even if it means they could be worse off because of the employer NICs hikes.
Combined effect
When combining the two potential changes—higher CGT and increased employer NICs—umbrella company contractors could face challenges on multiple fronts:
Investment worries: Contractors, especially higher-rate taxpayers, may face tax hits on both their earned and investment income. This could erode long-term financial security, as CGT increases reduce their ability to rely on investments, while higher NICs reduce their immediate earnings.
Behavioural shifts: Much like Sarah Coles from Hargreaves Lansdown points out, tax hikes could force contractors to alter their financial strategies. They might avoid selling assets to escape CGT, potentially locking up funds they could otherwise use. Similarly, higher NICs will mean contractors will have to negotiate higher rates to offset the losses in take-home pay. They must work with their recruiters to make this happen.
Disincentive to invest: Contractors, who may not have optimal pension contributions to salaried workers, may see these tax changes as a further disincentive to invest in stocks or other growth assets. This could limit their ability to plan for long-term financial stability.
Points to ponder
An increase in both capital gains tax and employers’ national insurance would present dual financial challenges for umbrella company contractors. On one side, higher CGT could dissuade them from making long-term investments, while on the other, increased employer NICs would reduce their immediate take-home pay. The combination of these factors could lower contractors’ disposable income and negatively affect their ability to save for the future. As a result, contractors might be forced to adjust their behaviour, by changing their investment strategies, negotiating their day rates and benefit packages or reevaluating how they structure their contracting arrangements, even if it creates barriers to future employment.
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