SHOW ME THE MONEY
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In "Freelancer's Guide to the Galaxy" we previously examined the rationale behind service companies (so-called umbrella companies) and how to choose an umbrella that's right for you and your circumstances.
Having chosen the appropriate foul weather gear, we can now embark on a journey into the murky world of Umbrellaology - the science (or dark art?) of umbrellas - where freelance earnings combine with employment concepts such as Pay As You Earn and Net Pay in a heady mix of rates, limits, figures and formulae.
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Let's set the scene: Jo-Anne Bloggs (or Jo Blo to her friends) is an intrepid yet wholly fictional IT consultant working on an assignment for a client appropriately called Show Me The Money plc. The rate she negotiated for her assignment is £375.00 per day. SMTM also agreed to reimburse her travel expenses up to £25.00 per day.
Having joined PMMC in July 2006, Jo's normal working practices and her contract with SMTM were evaluated by our specialist team and deemed (unfortunately for Jo) to fall within IR35, hence her full gross turnover is subject to PAYE Tax and National Insurance Contributions.
August was a busy month for Jo. While some of her new colleagues who are permanent employees of SMTM took time off for summer holidays, she worked a total of 20 billable days. She travelled to the client's office near Blackfriars Bridge by train every day, paying a daily return fare of £35.00. At the end of August she sent PMMC a copy of her authorised timesheet by email as well as the receipts for her train journeys.
On 3 September our Billing & Collection Department raised an invoice (dated 31 August) on Jo's behalf for a total of £9,400.00 (i.e. 20 x £375.00 + 20 x £25.00 + £1,400.00 VAT). SMTM usually pay promptly and on 15 September we duly receive a direct credit into our bank account for the full amount of the invoice.
Jo is a savvy freelancer who knows the benefits of planning ahead. She would like to take 3 weeks off in December to go skiing in the French Alps and hence she has asked her Engagement Manager to set aside £1,000.00 in September, October and November in order to receive a 'postponed' gross payment of £3,000.00 in December (in addition to any billable days worked in the month) to avoid 'lean times' in January. She is also contributing £526.25 per month towards an approved Pension Scheme to go towards a comfortable retirement.
Whilst our Jo is a real wiz kid as far as IT is concerned, she doesn't have much of a clue when it comes to Payroll, Tax, NI and "all that stuff". However, she would still like to know where her hard-earned money is going, so let us examine the monthly payroll and expenses process in detail and illustrate (by using September as an example) how those bean-counters in the Payroll Department are coming up with her net pay figure:
Step 1. Payment received before the payroll cut-off date is allocated to Gross Turnover for the payroll period.
Each month, a monthly payroll and expenses run is executed by our Payroll Department. The details used for calculation of this run are finalised on or before the payroll cut-off date and only payments that have been received before this date can be considered for inclusion in the particular payroll run.
In Jo's case, payment was received on 15 September (well ahead of the payroll cut-off which fell on 25 September) and hence her Gross Turnover for the September payroll period is £7,500.00 (20 x £375.00).
NOTE: Expenses recharged to a client do not form part of Gross Turnover and are therefore not subject to service charges. See also step 4 and 5 below.
- GROSS TURNOVER = £7,500.00
Step 2. Service charges are calculated (based on cumulative Annual Gross Turnover to date) and deducted from Gross Turnover.
PMMC's service charges are calculated as a percentage of Gross Turnover. The actual percentage is tiered, which means that the more you earn over the course of a year, the lower the percentage. (For full and up-to-date details on service charges, please refer to the Our Fees section of our website.)
Having started her assignment in July, Miss Bloggs had a Gross Turnover of £4,000.00 in the August payroll. Her cumulative turnover to date for the year starting in July is therefore £11,500.00, which means that she is still in the lowest tier and a service charge of 2.5% of £7,500.00 (i.e. £187.50) is levied in September.
NOTE: Service charges are deducted from Gross Turnover before the calculation of Tax and National Insurance, which implies that you get full relief on the whole amount.
- GROSS TURNOVER = £7,500.00
- NET TURNOVER = £7,312.50
- SERVICE CHARGE = £187.50
Step 3. Any Special Instructions (e.g. retention of funds, contributions to benefit schemes) are executed and Net Turnover adjusted accordingly.
Through our comprehensive Funds Management solution, we allow freelancers the freedom to choose how and when their money is remitted to them, as well as giving access to all kinds of benefits schemes that are usually reserved for permanent employees.
As per Jo's wishes, we set aside £1,000.00 to provide some 'holiday pay' later in the year. A further deduction of £526.25 is made from her net turnover to fund her contribution to a pension scheme. These pension contributions are paid over to the pension provider directly.
NOTE: Gross deductions are deducted from Net Turnover before the calculation of Tax and National Insurance, which implies that you get full relief on the whole amount.
- GROSS TURNOVER = £7,500.00
- NET TURNOVER = £5,786.25
- SERVICE CHARGE = £187.50
- RETAINED TURNOVER = £1,000.00
- GROSS DEDUCTIONS = £526.25
Step 4. Expense claims recharged to a client, submitted with receipts and authorised before the payroll cut-off date are paid directly via BACS.
Expenses are also processed as part of the payroll run. Our Expenses Department will vet all claims, ensure that these claims are properly submitted and substantiated with receipts as required. As is the case with payroll, only claims and payments that have been received before the cut-off date can be considered for inclusion in the expenses run.
In accordance with the terms of the agreement between Jo and SMTM, £500.00 (i.e. 20 x £25.00) of expenses were invoiced. After checking the receipts she provided, this amount is reimbursed to her directly.
NOTE: Authorised business expenses are reimbursed free of Tax and National Insurance under the terms of our Expenses Dispensation from Her Majesty's Revenue and Customs (HMRC).
- GROSS TURNOVER = £7,500.00
- NET TURNOVER = £5,786.25
- SERVICE CHARGE = £187.50
- RETAINED TURNOVER = £1,000.00
- GROSS DEDUCTIONS = £526.25
- RECHARGED EXPENSES = £500.00 (paid by BACS)
Step 5. Expense claims not recharged to a client, submitted with receipts and authorised before the payroll cut-off date are deducted from Net Turnover and reimbursed directly via BACS.
Expenses are also processed as part of the payroll run. Our Expenses Department will vet all claims, ensure that these claims are properly submitted and substantiated with receipts as required. As is the case with payroll, only claims and payments that have been received before the cut-off date can be considered for inclusion in the expenses run.
In addition to the £25.00 per day charged to the client, Jo has incurred a further £10.00 per day of allowable business expenses. (Remember, her daily train fare was £35.00.) After checking the receipts she provided, a further £200.00 (i.e. 20 x £10.00) is deducted from her net turnover and reimbursed to her directly.
NOTE: Authorised business expenses are reimbursed free of Tax and National Insurance under the terms of our Expenses Dispensation from HMRC.
- GROSS TURNOVER = £7,500.00
- NET TURNOVER = £5,586.25
- SERVICE CHARGE = £187.50
- RETAINED TURNOVER = £1,000.00
- GROSS DEDUCTIONS = £526.25
- RECHARGED EXPENSES = £500.00 (paid by BACS)
- NON-RECHARGED EXPENSES = £200.00 (paid by BACS)
Step 6. Employer's National Insurance Contribution (at 12.8%) is deducted from Net Turnover to yield Gross Pay for the period.
The first of the 'statutory' (i.e. imposed graciously by Her Majesty's Revenue and Customs) deductions through payroll is Employer's National Insurance Contributions (ER NICs). Calculation of National Insurance Contributions is somewhat technical and is based on a number of earnings limits and rates. The limits and rates for ER NICs are set annually in the Budget and currently stand at £420.00 for the monthly Lower Earnings Limit and a rate of 12.8%. (For full and up-to-date details on National Insurance rates and limits, please visit the HMRC website.)
Applying the limits and rates to Jo's net turnover, our Payroll Department arrive (almost as if by magic) at a gross pay figure of £5,000.00 and an ER NIC of £586.25.
NOTE: ER NICs are deducted from Net Turnover before the calculation of Tax and Employee's National Insurance, which implies that you get at least partial relief on the whole amount.
- GROSS TURNOVER = £7,500.00
- NET TURNOVER = £5,586.25
- SERVICE CHARGE = £187.50
- RETAINED TURNOVER = £1,000.00
- GROSS DEDUCTIONS = £526.25
- RECHARGED EXPENSES = £500.00 (paid by BACS)
- NON-RECHARGED EXPENSES = £200.00 (paid by BACS)
- GROSS PAY = £5,000.00
- ER NICS = £586.25
Step 7. Further deductions are calculated and applied to Gross Pay to yield Net Pay.
Further statutory deductions (i.e. PAYE Tax and Employee NI Contributions) as well as all other net deductions are calculated based on tax code, NI letter and other information and applied to gross pay to finally arrive at net pay. As is the case for ER NICs, calculation of Employee National Insurance Contributions (EE NICs) is somewhat technical and is based on certain earnings limits and rates set annually in the Budget. (For full and up-to-date details on National Insurance rates and limits, please visit the HMRC website.)
Once again, our Payroll Department work their magic and arrive at the figures for PAYE Tax (£1,311.00) and EE NIC (£283.30) based on Jo's tax code (503L) and NI letter (A), which leaves her with the grand total of £3,405.70 after the state has extracted it's pound of flesh.
- GROSS TURNOVER = £7,500.00
- NET TURNOVER = £5,586.25
- SERVICE CHARGE = £187.50
- RETAINED TURNOVER = £1,000.00
- GROSS DEDUCTIONS = £526.25
- RECHARGED EXPENSES = £500.00 (paid by BACS)
- NON-RECHARGED EXPENSES = £200.00 (paid by BACS)
- GROSS PAY = £5,000.00
- ER NICS = £586.25
- EE NICS = £283.30
- PAYE TAX = £1,311.00
- NET PAY = £3,405.70 (paid by BACS)
Step 8. The resultant Net Pay is paid out via BACS; PAYE & NICs are paid over to HMRC.
Once all the calculations are done, all that remains is for Jo's net pay to be paid into her bank account while all the statutory deductions are dispatched to HMRC. Due to the separate processing of expenses, Jo will receive two payments, the first for an amount of £3,405.70 (her net pay) and the other for £700.00 (her expense reimbursement).
That, in a nutshell, is where the money goes...
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At PMMC, we are committed to ensuring that our portfolio of services remains fully comprehensive and we give all our 'freelance employees' this promise: If they come across a service or benefit (offered by another umbrella company) for which we have no equivalent, we will strive to add it to our repertoire, as long as it is legal, compliant with current regulations and commercially viable.
Our Service Charges (which include access to ALL services) are set at a maximum of 2.5% of turnover and are tiered, hence the more you earn, the lower the rate will be in relation to your income. There are no setup charges, joining fees or termination penalties. No additional costs are incurred by working directly with a client and not via an agency or intermediary, nor would there be any fees to pay when you are not working on an assignment.
Whether looking to become a freelance professional for the first time, mid-way through an assignment or currently between contracts, there has never been a better time to join the ranks of PMMC's many partners in all sectors of the contracting market: Education & Training, Engineering & Manufacturing, Finance & Banking, Hospitality & Catering, IT & Telecoms, Medical & Pharmaceutical and Sales & Marketing.
Editor's note: Johan Steyn has been working as a freelance Enterprise Resource Planning & Management Consultant for 10 years and he is the founder and Managing Director of PMMC (UK) Limited.
