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In light of the recent legal judgement handed down by the European Court of Justice (ECJ), intouch has received a number of questions from clients who are concerned about their exposure to risk in relation to the tax status of limited company contractors. We asked Kevin Barrow, Head of Outsourcing & Partner at leading London law firm, Tarlo Lyons to respond to one of their most common questions. |
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Is the tax status of limited company contractors under attack?
In the last few years the UK government has said it recognises that the use of temporary and contract workers plays an important part in the UK labour market's flexibility and economic success. Various ministers have stated that they understand that contract working provides career opportunities, flexibility (e.g. for primary
carers of children) and lifestyle opportunities (for example for people who are fed up with the treadmill of 9 to 5 working for one employer which probably does not offer the same level of pension benefits as it used to).
However there are a few people who do not seem to be very happy with the increasing prevalence of temporary and contract working. One of the least happy groups is the UK tax authorities. It is well known that contract working via a limited liability company can offer a number of tax savings for the contractor. Provided he falls outside IR35 he is usually able to put a number of personal expenses through his company and then draw down the balance of his gross remuneration as dividends (which reduces NIC's). The Treasury is aware of this and has been looking at the situation for some time. In January 2005 the Treasury said that it was aware of "the increasing number of self-employed individuals adopting this corporate legal form for tax reasons rather than as a step to grow, often as marketed tax-avoidance schemes". More recently in March 2006 the Chancellor stated that "further evidence has emerged that employment income is being disguised as dividends in order
to take advantage of the small companies' tax rate, often encouraged by promoters of mass-marketed managed service company schemes." The Chancellor went on to say that he "believes that all individuals
and businesses must pay their fair share of NIC's in tax, irrespective of legal form...As the first stage of this review the Government will consult on action to tackle disguised employment through managed service company schemes".
So what is going to happen?
At the time of writing it seems likely that the Chancellor will make some announcement about new proposals in this area in his pre-budget statement on 6 December 2006. This announcement follows a period of about nine months during which the Treasury has been drafting a "technical note" setting out proposals for new definitions of employment and self-employment for tax purposes. It is not clear what the Treasury's proposals will consist of but it is quite clear that they have found this drafting exercise more complex than they originally thought it would be.
What are the Treasury's options in relation to alleged "disguised employment"?
There will clearly need to be a period of consultation and one possible outcome is that the Treasury will decide to do nothing (because this is too complex an area to be easily solved by new legislation).
What are the Treasury's other options?
Our view is that the Treasury's options include the following:
- HMRC could employ more tax inspectors to enforce the existing IR35 and PAYE/NICs regime. We consider this unlikely in light of recent announcements about civil service job cuts.
- Change the IR35 tests placing the burden of proof of self-employment on the tax payer (instead of HMRC) and/or categorising people's IR35 status by reference to the precise occupation they have (e.g. "supply teacher at primary school") rather than by reference to employment case law. Another IR35 "tweak" could involve saying that IR35 would henceforth apply to all "self-employed" people unless they themselves have their own employees and spend not more than 75% of their time working for one client (which is an approach which has been adopted in Australia ).
- We could see an entirely new statutory definition of who is and who is not an employee for tax purposes which seems to be what the Treasury's technical note is designed to deliver. Our view is that if it were easy to come up with such a definition it would have been invented a long time ago.
Whatever the outcome one obvious lesson is that contractors anxious about their tax status should be careful to supply their services via managed service companies who are sophisticated enough to provide limited company solutions with a good chance of falling outside any attack by the UK Government in the next few months. Of course, selection of suitable advisors in this area is a matter for each contractor and not something which we can advise on in this newsletter or a recruitment company would generally seek to advise on; one feature of being genuinely "self-employed" is that the self-employed person selects his or her own staffing company partners, contracting model and advisors. Careful selection of those partners, models and advisors is now, however, more important than ever.
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