Contractors may have breathed a sigh of relief following the pre-budget report having found little changed. However can any tax payer really expect to pay the same tax/NIC post general election?

Considering the state of the UK’s finances the answer has to be a resounding no. The electioneering has begun and we hear calls from one party for a £10K nil rate tax band, accusations from the current incumbents of a forthcoming class war but the emphasis from all three main parties is clearly on fairness.

IR35

Public campaigns for the repeal of IR35 have so far failed. If they had succeeded it would be unrealistic in the extreme to expect in its place a system where less or even the same tax/NIC is generated from those operating through limited companies.

The Agency Workers Directive (AWD) calls for a definition of the genuinely self-employed and suggests that those outside IR35 would also be outside the AWD. This new legislation presents a real opprtunity for end clients and agencies to understand and address the issues of employment status. We could at last see an end to engagers who want all of the controls over the freelancer as an “employer” but with none of the responsibilities that an employment relationship brings. The AWD in its current form also addresses the perceived unfairness with regard to employment rights for those inside IR35.

Umbrella Companies

Arguably expenses for Umbrella users were saved thanks to the Daily Telegraph! The future is the flexible workforce and there is still an important role for umbrella companies to play. HMRC has fired several warning shots regarding Umbrellas use of over- arching contracts of employment and it seems there are numerous ones out there that do not work. Returning to the issue of fairness and the fact that agency workers generally cannot claim expenses the Umbrella user may find him/herself in the same position as the PAYE agency worker.

Changes

Brace yourselves for a change of government, an emergency budget and more tax to pay.

Opportunities

New regulations bring opportunities for education and better understanding of employment status issues by all the parties in the contractual chain which is good news for Contractors.

In the meantime we still have IR35 and Umbrella expenses schemes and HMRC is very much out there using its new powers and spending its enormous budget on compliance work. 2010 is going to be a year for all contractors to take notice of the changes and the opportunities and consider their positions accordingly.

Kate Cotterell is Managing Director of Bauer & Cotterell.
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At one point it seemed as though HMRC’s radar was focused solely on the Construction Industry, but now their gaze has fallen hard and fast on limited company contractors (yet again).  In the last month Accountax have seen a 162 % increase in the number of IR35 enquiries instigated by HMRC.

These enquiries, spurred as usual, off the back of Compliance visits and HMRC’s new powers of inspection see HMRC firing on all cylinders, and doubling their resources for compliance.

It is now more important than ever to ensure your company is fully compliant and know what the law says.  Fundamentally though you must get it into your head that as soon as HMRC write to you or your accountant requesting a Compliance visit they will look at IR35.  Do NOT be lulled into a false sense of security that IR35 is not in their mind.  It is.

Secondly you must not be swayed from your arguments.  It comes down to three fundamental criteria:

Personal Service

Are you obliged to do the work yourself?  If not, then IR35 cannot apply.  Do you have a right to send a substitute?  Is the substitute only vetted to check skills, qualifications or experience?  If this is the case you are not obliged to provide personal service and as such IR35 does not apply – you do not have to SEND a substitute, the right to send one is sufficient.

Control

Are you told how to do the work?  If not, then IR35 cannot apply.  If the manner in which you provide the services is your own (ie you determine how you will design, approach, develop and actually carry them out) this is sufficient.

Mutuality of Obligations

Are you obliged to do the work, and is there an obligation to provide you with work.  If no such obligation exists IR35 cannot apply.

HMRC must establish that all 3 criteria exist before IR35 can apply.

In Business factors

the final consideration is the “in business” test.  Do you invoice?  Do you have insurances? Do you have company equipment and materials?  Are you identified separately as a contractor?  These factors will all help to demonstrate you are in business on your own account, but they do not determine IR35 on their own.

Obviously these factors, on the face of it, are fairly straightforward.  The problem arises due to badly drafted contracts which do not contain clearly how the contractor provides the services.  Most limited company contractors I have dealt with would not tolerate, nor adhere to, being treated like an employee by the end client.  The problem is the contract does not reflect this.

Agencies are slowly realising the dangers of IR35 (which has taken long enough), and now is the time for contractors to strike and ensure they get their contracts reviewed properly and negotiate with the agencies to implement the terms they want!  It can be done – persistence is not futile!

What contractors must not do is jump ship to umbrella companies merely because they are scared of IR35 – you may simply be jumping out of the frying pan into the fire!  Umbrellas received a mention in the Pre Budget Report, yet again, warning of a consultation process.  While I do not practically see how HMRC could possibly legislate against umbrella companies, HMRC have increased their efforts in targeting umbrella companies and Accountax are now dealing with double the amount of umbrella company investigations.

Not all umbrella companies will fall foul of HMRC, and not all should be avoided, however there are still a great many who exploit the expenses legislation and play on a contractors fears of IR35.  Umbrella companies work well for a number of individuals but they do not work for everyone!

Things contractors should beware of:

“fully IR35 compliant”. IR35 does not, and can not, apply to umbrella companies.

“approval”.  Third party “approval” or “accreditation” does not mean the umbrella is compliant, it simply means someone has checked them for MSC implications, and not for basic compliance.  This is of little benefit to a contractor.  Accountax have seen a number of umbrellas with third party approval for MSC implications fall foul of HMRC because they have not operated expenses, employers’ obligations etc properly.  If an umbrella company has not paid your tax across, or processed your expenses correctly HMRC can pursue you for the liability.

“option”, “solution”, “scheme”.  Be wary of companies offering a variety of options or solutions and various tack on services such as recommending accountants etc.  Any company stating on a website they offer “solutions” are sure to be high up on HMRC’s radar and attract unwanted attention.  If they are offering a “one stop shop” it is likely they will be considered a scheme by HMRC and caught by the MSC legislation.

“dispensation”.  Any company promoting the fact they have a dispensation as part of their marketing strategy should be viewed with caution.  A dispensation does nothing more than “dispense” with the umbrella company’s need to produce a P11D.  It does not allow you to claim expenses you have not actually incurred, if a company is telling you this you could find yourself personally liable.

These are just a few things to be wary of, unfortunately for contractors for every one umbrella which operates correctly there are a dozen who do not.  Umbrellas can work well for contractors, but likely if a limited company is suitable for you an umbrella would not be. Your best bet is to get your IR35 position checked thoroughly by a professional adviser who can back up their claims (do they represent at tribunal level for example).  One golden rule – DO NOT JUMP FROM YOUR LIMITED COMPANY WITHOUT ADVICE.

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While it is fair to say that IR35 will have an impact on your own net income, quantifying exactly how much impact is not that simple, since there are several variables. You can, however, compare the overall results in general terms.

There are basically four ways to get paid as a freelance contractor: under normal PAYE, either on a fixed term contract or as an agency employee, through an Umbrella company, with your own company operating inside IR35 or with your own company operating outside IR35.

Normal PAYE

Whether you are on a Fixed Term Contract – essentially a normal employment contract but with a pre-agreed termination date – or are employed by the agency who found the work, you will be treated as a normal employee for tax purposes and pay all the usual taxes and NICs. Expenses are very much at the discretion of the employer or agency, but will be limited.

IR35 cannot apply and hence has zero impact.

Umbrella Company Contractor

You are in effect an employee of the umbrella and so IR35 cannot apply. Once again, you pay full PAYE and NICS on your income. However, out of your gross you also have to pay Employers NICs (usually the contract rate will have been raised to cover this cost) and the umbrella’s service fees. You can, however claim various working expenses that will reduce your overall tax burden; in effect the costs you incur by working become tax-free income. Beware, though, that all such expenses have to be justified and verifiable and treat claims by umbrellas that they have generous expense policies to increase your take-home with a degree of caution. The umbrella will also make other deductions to cover various statutory requirements such as holiday pay and pensions

The end result is you will take home more net income than straight PAYE, precisely how much depends on your level of working expenses.

Own Company inside IR35

At its simplest, and starting with your gross income from the contract, you can deduct 5% to cover operating costs of having your own company, allowable business expenses such as travel and equipment costs, Employers NICs paid during the year and any salary paid during the year. The balance remaining is the “Deemed” income and is liable to full PAYE and NICs.

In terms of overall impact, you are paying tax on 95% of your gross rather than the 100% if you are working through an umbrella, so there is a small benefit to this approach.

Own Company outside IR35

You can set a salary level of your choosing and then take any post-tax profits in the form of dividends, which are not liable to NICs. Setting a gross salary to the same as the tax free personal allowance therefore means you can save significant amounts of taxation. You offset salary payments, working expenses and other costs such as training (which is not allowable under IR35) and pension payments against your gross, pay Corporation Tax on the net profit, the balance being the amount available to you as dividends. You can also leave some or all of those profits in the company for later years.

The overall impact is that you will retain a higher percentage of your gross income than through any other route. However, it does mean that you have to be certain of your IR35 status.

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