Contractors, whether new to contracting or experienced hands, will often be approached by salesmen for tax-efficient pay structures.

You will hear claims such as ;

• We can guarantee you 90% take-home pay
• HMRC compliant
• Guaranteed legal
• Approved by leading Tax Counsel

Great – where do I sign?” might be your first thought. However, you might want to reflect and find out a few things before committing yourself.

How long has the company been around?

Claims are often made that ‘we have been providing contractor solutions for 6 or 7 or 8 years’. Check with Companies House and you may find that the company is relatively newly formed. This could mean that :

a) The company will have little or no track record with HMRC.
b) The company may have no asset base so nothing to fall back on should there be difficult times such as an HMRC investigation.

How can you guarantee take-home pay percentages?

The real answer is that you can’t. It is very dependent on personal issues such as your tax code, previous income and other income. Also, measuring take-home pay is one thing but there is often hidden higher rate tax to be paid via your Self Assessment Tax Return after the end of the tax year. You will also find that a large proportion of the sum that you don’t take home is taken in advisers fees with very little actually paid in tax.

HMRC compliant – surely that’s a good thing?

This may not be as impressive as it sounds. Compliant may mean as little as the fact that the company has registered a PAYE Scheme with HMRC, which is something that it must do to employ people in the UK. They have therefore complied with the basic rules of employing people. Not quite the same as the impression they are trying to portray – that HMRC have looked at, and are happy with the overall way that the company operates.

Guaranteed legal – can’t go wrong with that can you?

Businesses don’t normally state this – only if you are sailing so close to the wind do you think it’s necessary to state it. It may also just appear to be legal – until HMRC proves otherwise, that is.

Approved by leading tax counsel – surely you can trust the opinion of a QC?

Yes, of course you can. But was the QC given a full disclosure of all facts and what was the actual opinion? It is rarely as simple as ‘Yes, that works.’ And also very unlikely that it would be something that you could rely on in Court if you needed to.

So what do I do?

Be cautious and take professional advice from someone you can trust, like your accountant. Only proceed if you are absolutely sure about the scheme. If you get it wrong it’s you that pays the tax, and the interest, and the penalties.

John Mumford is the Accounting Director of Carrington Accountancy
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Finance professionals and contractor accountants do not believe that the government’s proposed plans to overhaul the PAYE system are satisfactory.

Last week, HMRC released plans for the significant reform of the PAYE system since its introduction 66 years ago. With the new system, employers would remain responsible for the calculation of NIC, PAYE and student loan deductions and that information would be sent to HMRC via the BACS system when the employer runs the weekly or monthly staff payment run.

One of the fears amongst tax experts is that the Revenue is not famed for successfully implementing new IT systems. The most recent example being the chaos that ensued earlier this year when taxpayers were sent incorrect coding notices due to a data migration project.

Karen Thomson from the Institute of Payroll Professionals said that whilst the idea is good in principle, there are certain issues that need attention before the organisation would support the proposal.

One concern is that employers would be giving employees a payslip that does not tell them their take home pay. The chairman of BASDA’s payroll special interest group, Andrew Dove, said that this could have a negative impact on low paid employees and people who work fluctuating hours. Payroll software providers are also concerned that the new proposal will kill standalone payroll products. Although the payroll year end bottleneck would be eliminated with the new system, it would make more sense to process real time information through existing payroll software and the current government gateway, Dove added.

Tax specialists are agreed that further research and consultation is required before a new scheme is piloted. Baker Tilly’s tax director, Lesley Fidler, hopes the new initiative will be researched fully, piloted adequately and funded sufficiently before it is generally adopted.

At present the proposed reforms are at the discussion stage and suggestions from professional organisations will be taken into consideration before a formal consultation document is issued.

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IT contractors who have been taking advantage of HMRC’s seven day grace period need to be aware that the concession is being axed as from March 31, 2011.

This could lead to an increase in the number of small business owners and freelancers turning to an IT contractor accountant for advice in completing their tax returns.

HMRC introduced the Extra Statutory Concession B46 in 1995 and employers and contractors were not penalised provided their company tax returns were received within 7 working days of the filing date.

Once the ESC B46 comes to an end, returns must be filed online by the specified date otherwise contractors will automatically face penalty charges. These can only be removed if a special request, detailing the reason for the delay, is made to HMRC. A spokesman from the Revenue said that every case will be considered on its own merits.

HMRC has decided to withdraw the concession because all returns are now filed online and so postal delays no longer affect filing dates.

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Now the excitement of the promise actually to consider IR35 for a serious reappraisal has died down a little, I’ve been giving some thought to what that might actually mean. What can we expect Son-of-IR35 to look like?

For one thing, I think there will still be something there that looks like IR35. Let us not forget that the original justification was to prevent the Friday-to-Monday syndrome, where a worker would switch from permanent employment to freelance contract doing exactly the same job. Either the worker did this to take advantage of the tax breaks available to a Ltd Co owner or, more often than people would admit, it was the employer divesting himself of assorted legal obligations, not to mention having to pay Employers NICs.

Of course IR35 stops this, by making the cost benefit of doing this unattractive. Snag is, it also gets in the way of the worker who genuinely wants to go freelance. So my suggestion is that IR35 (or whatever the new version is called) should only apply where the freelance’s client is the same as the immediately previous employer for a period of one year.

However, if we assume that some form of IR35 is still out there post review, the best we can hope for is that there are clear rules about when it applies. Most contractors are angrier about the lack of clarity and resultant uncertainty than about paying the taxes, after all. This is here the original “in business” test comes in – you know, the one that Red Dawn prattled on about while simultaneously refusing to accept that any freelance could possibly be in business on their own account.

But how do you demonstrate you’re in business? That’s the question…

One option is if you are VAT registered. There’s no way you can do that as an employee; even if you did, there would be precisely zero things you could legally claim the VAT back from anyway. You could add in the existence of Your Co to make the test a bit firmer, although that might impact the Schedule D Self-Employed workers. Although the Schedule D self-employed worker can’t really be hit by IR35 since there isn’t an intermediary company in the chain anyway.

Another option is to waive your rights to things like employee benefits, JSA, maternity or paternity leave and the rest of the panoply of employee benefits. The logic is that since you are not paying employee-level taxes, why should you expect to get employee-like benefits?

You could be a bit more imaginative and scrap S44-47 ITEPA 2003 (which replaced S134c) which is the one that makes the intermediary liable for unpaid taxes and is why agencies won’t deal with unincorporated (or non-umbrella) contractors in the first place. Which – whisper it quietly – is why we then got IR35…

Or, of course, you simply delete IR35 altogether – with the sole exception I mentioned above to stop the Friday-to-Monday trick. If there’s no law, there can be no uncertainty. Freelances can choose to work through an entirely legal UK Limited Company and operate it just like every other one. A bit like I do right now.

Or is that too simple…?

Anyway, end of contract today so I’m off for two weeks in the sun. Since I refuse point blank to take my laptop on to the beach – and she who must be obeyed would flay me alive if I tried – the next blog will probably be on June 25th. Let’s hope there’ll be something to write about!

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According to the results of a new survey by online accountants Sage, the UK tax system needs to be radically simplified.

This is the view of over 2,000 self employed contractors and small companies who took part in the survey in March 2010. Overall, the respondents felt that the rules governing PAYE, VAT and Corporation Tax are way too complicated and as many as 80% felt that current legislation was preventing both them and their contractor accountants from seizing tax planning opportunities.

The research found that nearly two thirds of SMEs did not know what tax allowances there are entitled to. Furthermore, over 70% felt that the tax system in this country was actually acting as a barrier for many would be entrepreneurs.

Small businesses are generally regarded as engine room for economic success in the UK and have become a key focus for the main political parties as we enter the final days of the election campaign. The proposed hike in employer’s national insurance contributions is still dominating the political landscape and many experts now feel that this could be the tipping point for a Tory victory.

A spokesperson from Sage said that there is a great deal of confusion in the SME marketplace with regard to the tax system in this country. They suggested that this was the cause of huge frustration amongst small businesses, many of who do not seek the advice of their accountant as much as they should do.

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HMRC is urging sole traders and contractors, as well as employees, to get in contact with their local tax office if their tax code looks unusually low or high.

Contractor accountants should also be vigilant, however it is unlikely that they would be able to spot all errors across their client base. Therefore they should advise contractors and sole traders to check their own tax codes where possible.

HMRC recently updated it’s PAYE and NIC system which is believed to have caused the errors.

Most people will have a personal allowance of £6,475 in the tax year covering 2010 and 2011. Those with an incorrect tax code will be paying the wrong amount of tax from the start of the new tax year from April 2010.

If you believe your tax code may be incorrect, have a look at HMRC’s notes included with the coding letter or go to the HMRC website for information. If you still believe there is an error, HMRC have opened an advice line 0845 3000 627 specifically for those with a tax coding issue.

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There have been a number of cases in recent years, the majority of which have been employment tribunal hearings, involving the disgruntled self-employed claiming employment rights against their customer/client and succeeding.

Such instances normally arise when the client seeks to terminate or reneges on previously agreed contractual terms thereby aggravating the self-employed person(s).

In the recent case of The Athenaeum Club v HMRC & Becaglia, heard in the First-Tier Tax Tribunal, such actions led to the “client” being liable to £7,300 PAYE and NICs for the two years ended 5th April 2005 notwithstanding any interest or penalties.

Mr Becaglia was originally interviewed for the post of Fitness Manager at the Athenaeum Club but his experience was recognised as being useful to growing the business of the club and he was subsequently offered the position of Assistant Manager with a salary of £22,500, which he duly accepted. On the agreed start date, however, Mr Becaglia expressed concern that full time employment would hinder his business interests and he renegotiated his position.

The Athenaeum Club asserted that an agreement existed with Mr Becaglia’s business “P3/Propaganda”whereby the club would be invoiced on a monthly basis for the provision of Mr Becaglia’s consultancy services. Whilst invoices were raised by “P3/Propaganda”, which included VAT, the amounts represented twelve equal instalments of an annual fee of £25,000 and payment was made direct to Mr Becaglia. All expenses that were made on behalf of the club were reimbursed to Mr Becaglia.

Mr Becaglia advised on projects and areas of potential growth for the club but the club supervised and decided upon tasks and duties. He worked on a daily basis at the club’s premises but he did have discretion over his working hours.

On 25th January 2005, the club entered into a settlement following Mr Becaglia’s claim for unfair dismissal. The agreement stated that Mr Becaglia was an employee from 7th July 2003 and that the club undertook to pay income tax and NICs as required. Mrs Jones, a manager at the Athenaeum Club and who also represented her employer at the hearing, said that the agreement had been reached on solicitor’s advice and was a commercial decision to curtail expensive legal costs. The agreement had been ratified by the Managing Director in Mrs Jones’ absence but she maintained that had she been present the term “employee” would not have been used.

The Tribunal agreed with HMRC that the settlement document carried significant weight and made it clear that Mr Becaglia was an employee. It was not enough, however, to determine the status issue but when other status factors were considered, i.e control by the club, lack of financial risk and integration, the same conclusion was reached.

Whilst it was accepted that Mr Becaglia conducted other business outside of his role at the Athenaeum Club, the Tribunal found that it was entirely feasible for an individual to be employed in one capacity whilst simultaneously self-employed in separate ventures.

In reaching their decision the Tribunal noted that it had done so with reluctance as it seemed that Mr Becaglia had deliberately manipulated the situation to his advantage and left the club holding the baby.

This case highlights the need for proper contractual terms and conditions to be drawn up and agreed upon from the outset by both parties together with professional advice. Periodic reviews of a workers’ status should also be carried out to satisfy both the engager, worker and ultimately HMRC that a worker is genuinely self-employed. Had the Athenaeum Club done so they would have saved themselves a lot of time, hassle and money.

Seb Maley is a Freelance Serves Manager at Qdos Consulting
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We are aware of HMRC plans to offer medical professionals a disclosure opportunity in respect of unpaid taxes. The Tax Health Plan will allow medical professionals the chance to disclose any arrears and settle them with interest and a ten per cent penalty.

Those who fail to make a disclosure who are subsequently investigated by HMRC and found to owe taxes could then face a one hundred per cent penalty.

HMRC have accessed information regarding the earnings of medical professionals from the NHS, medical health insurance companies, private hospitals and certain contractor accountants. Prior to acting on the information they hold, HMRC are offering medical professionals the opportunity to confirm their intention to disclose their earnings by 31st March 2010. They will then have until 30th June 2010 to make their full disclosure.

Mike Well from HMRC has suggested that the government already has an abundance of information at it’s disposal that could be used to investigate medical professionals. He said “I strongly urge any in this group who think they may have outstanding tax liabilities on their income to get in touch with HMRC and get their tax affairs in order simply and on the best available terms.”

This disclosure opportunity is likely to be extended across other sectors in the future. Contractors using umbrella companies , such as Crystal Umbrella, are unaffected since their taxes are deducted fully through PAYE. It is expected that the umbrella model and online accountants will become increasingly more popular with medical professionals who are keen to minimise their taxes without the hassle of extra administration.

Scott Illingworth is Director of Service Delivery at Crystal Umbrella.
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Probably. The rather circular definition of a Managed Service Company is one that is provided by a Managed Service Provider. Since these were effectively outlawed in 2007, it is important to understand how they are defined.

MSCs were a way to operate an independent business with minimal involvement in its day-to-day running. The provider would set up a composite company in which you would have a shareholding usually in the form of a unique class of shares in your name. You would be paid in direct proportion to the work you did and hence the income you generated. The provider would handle all the billing, payment and taxation activities on your behalf.

However, HMRC decided, with what some might say was justification, that operating in such a way was more to do with saving tax and NICs than it was to do with running a business. They closed down MSCs by ensuring that they only paid their workers through conventional PAYE/NIC, not through dividends: in effect they became more akin to umbrella companies.

The difference between using an MSC and using an accountant to manage your affairs is therefore important. A Contractor Accountant is in fact defined specifically in the rules. They cannot be an MSC Provider as long as they do not do any of the following activities:

• benefit financially on an ongoing basis from the provision of the services of the individual,
• influence or control the provision of those services,
• influence or control the way in which payments to the individual (or associates of the individual) are made,
• influence or control the company’s finances or any of its activities, or
• give or promote an undertaking to make good any tax loss.

So as long as you are the one whose name is on the chequebook and decide what cheques to sign, you cannot be an MSC.

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If you are in business on your own account and working through a limited company, how you take money from the company to pay your bills is entirely up to you. There are no set rules you need to adhere to about how you do it.

However, how much tax you pay will depend very much on how you structure the payments from your company to you. This can get complicated, especially if there is more than one shareholder to consider, so it is best to get professional advice at first and to review that advice as the taxation landscape changes. However, there are some broad guidelines.

You can take any salary you like or none at all. You need to think about your personal tax-free allowance though; this is the amount you are allowed to earn before tax becomes due and is set by your Tax Code.  Therefore you can take that amount of money as salary and not pay any income tax on it. You should also remember that a range of state benefits depend on you paying National Insurance contributions. These are due once you exceed the earnings threshold (currently £110 a week). So the absolute minimum to pay yourself is £5720 a year, or your personal tax-free allowance, which ever is the higher.

Dividends are payable from net profits after Corporation Tax. You can take them at any time, and as often as you need to, provided the financial status of the company is such that it can afford to pay them. Because dividend payments attract a tax credit – to offset the Corporation Tax already paid by the company – dividends up to the upper-earnings limit – the point when the higher rate of income tax kicks in – will not be liable to further income tax. Once you go over that limit, tax is due at the higher rate less the tax credit; at the time of writing this means an effective tax rate of 22.5% (this is because the tax rates for dividends are 10% and 32.5%, both reduced by the 10% tax credit; hence zero extra tax at lower rate and 22.5% at the higher). Dividends are not liable to NIC payments.

Despite what some umbrella companies claim, expenses are not income. In fact, if properly calculated they are income neutral. Provided you have actually spent the money and that you spent it wholly and exclusively as a result of your work, you can reclaim it tax free. It is not, however, tax-free income, and if you are making money on expenses you are probably doing something wrong.

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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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When a company is closed down and all its various taxes and debts paid off, there is usually a sum of money left over. This money belongs to the shareholders of the company and is usually distributed to them as a final dividend.

As usual this is treated as personal income by the shareholder and tax is to be paid on it, less personal allowances and company tax credits.

However, you can apply for the cash to be distributed as Capital rather than as a dividend. To do this you make an application to HMRC under the provisions of Extra Statutory Concession C16, or ESC c16 for short.

The benefits of doing this are that the monies are then liable to Capital Gains Tax rather than PAYE. CGT is due at 18% of the total less the annual allowable amount, currently £100,100 for the typical shareholder. This can represent a significant saving, especially if the shareholder has already used up their annual tax allowances.

To follow this route you should get professional guidance and write a formal letter to HMRC, signed by all interested parties. Furthermore, the application must be made and approved and all monies paid before the company is closed under the provisions of Section 652 or 652A, so some forward planning will be needed.

You can only apply for ESC c16 if you meet the following qualifications:

The company must not be subject to an investigation either by an individual or a corporation
The company must not intend to trade in the future
All creditors and debtors must be paid
The company will distribute all of its assets to its shareholders
The company must intend to seek or accept a striking off order and dissolution
The company must pay all of its corporation tax due
The officers and shareholders of the company must pay all CGT due
Finally, if the company is not subsequently closed down, HMRC have the right to cancel the order and reclaim the full tax on the assets.

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