Buried at the end of the long batch of press releases issued by the Treasury, Customs & Excise, and Inland Revenue immediately after the budget was a little gem entitled 'IR35 - Countering Avoidance in the Provision of Personal Services'.
The changes are intended to come into effect from April 2000, and Contractors are beginning to realise that these proposals may fundamentally affect not only each of them as individuals, but the contracting industry as a whole. Whether these fears are justified or not - and whether ways to avoid the most serious effects can be found - will depend on the way in which the new legislation is structured. And that, at present, we can only guess at.
The Present Position
Let's take a situation where the Client is paying the agency £10,000 per month, and where the agency's margin is 15%. After deducting the margin, the agency has £8,500 available to pay the Contractor.
Case 1:
If the contractor is one of the few who contract with an agency themselves (rather than through a company), then existing legislation provides that the Agency must account for PAYE and NI from all payments made in the same way as they would if the Contractor were an employee of the Agency. So first provision has to be made for Employer's NI of £993 (current rates), leaving £7,507 as the Contractor's gross income.
Then Employee's NI of £188 is deducted, and PAYE - assuming the Contractor has the single Personal Allowance and no other source of income, then this will be £2,445 - resulting in a net payment to the Contractor of £4,874. Such contractors are unlikely to be affected by the proposals.
Case 2:
Most Contractors however trade using their own limited companies. The agency pays the company gross - £8,500, following the above example. The Company pays the Contractor a small salary (typically £6,000pa - £500 per month), and dividends. So the company pays Employer's NI of £17, deducts Employee's NI of £21 and PAYE of £14, and the Contractor receives a net salary of £464. The company is left with £7,893 profit, on which it will pay Corporation tax of £1,596, leaving £6,386. This it pays to the Contractor as a dividend; the Contractor then has to pay tax at 20% on so much of this as is taxable at the higher rate - this comes to £838. The Contractor receives the total net sum of £6,013.
End results:
Contractor Employer's NI Employee's NI Tax
Case 1 4,874 993 188 2445
Case 2 6,013 17 21 2449
Thus two points emerge from this illustration: (1) the Contractor using his own company is about £1,150 per month better off; and (2) the saving is at the expense of NI.
Proposed Changes
The Inland Revenue statement expresses 'concern about the hiring of individuals through their own service companies so that they can exploit the fiscal advantages offered by a corporate structure', and suggests that legislation will be brought to tackle this 'avoidance'. The aim of the proposed changes will be to ensure that people working in 'disguised employment' pay the same taxes and NI as those employed directly. So far, this sounds very worrying.
The statement goes on to say that the changes are 'aimed only at engagements with essential characteristics of employment', and says that there is 'no intention to redefine the existing boundary between employment and self-employment'. And this, I think, is where the solution for this industry is likely to be found - assuming of course that this statement ends up being reflected in the legislative changes.
These boundaries are matters of established law - one has to look at various aspects, and then form an overall view - the kind of task beautifully summarised by John Thaw's character in Kavanagh QC last week, when he said 'our task as lawyers is to take infinite shades of grey and turn them into black and white'. - or words to that effect. 'Badges' of employment are:
On the other hand 'badges' of a separate business (and therefore likely to be unaffected by the changes) are:
The opportunities offered to Contractors at present by the use of their own companies have been largely responsible for the growth of the contracting industry in this country - and, from what I see, we have the largest such industry of any country at the present time. From the Client's viewpoint, I suspect the prime attraction is the freedom to recruit and dispose of individuals with specialised skills according to need, without the hefty overhead imposed by protective employment legislation. Advantages to both sides have 'made it work', and business, individuals, and the country as a whole have benefited. Service businesses have sprung up around the industry - agencies, specialised accounting firms, and indeed my own business.
Other countries in the EU have legislation which, on the face of it, makes it harder for Contractors to take advantage of the structure they are accustomed to using. Structures have however been devised to find ways round such legislation - Germany is a typical example, where contracts are structured in a way that is more project-based than time-based.
At present, we can only guess at:
I've spoken to several people on the subject over the past couple of weeks; each has their own idea. But whatever the idea, it can only be guesswork at the moment - we cannot plan until we know exactly what we have to face. And we will have that opportunity - we will know what the proposed legislation is, before it takes effect.
It seems to me that the way forward is:
Whichever way you view it, the fact is that Contractors, Agencies, and Clients all have the same vested interest in preserving the industry, and are likely to cooperate. And given that, I would be very surprised if solutions did not emerge which at least substantially reduced the problems feared.
I suspect that at least one of these ways will revolve around restructuring contracts, wherever practicable, in a way so as to make it clearer that the reality of the arrangement is not 'disguised employment'.
In the meantime, contractors should be wary about signing contracts where the duration extends beyond 5th April 2000 - thus allowing for any necessary restructuring as and when we know more.
The press release in question (and the address to which to write to make representations) can be found at:
http://www.hm-treasury.gov.uk/budget99/nr/ir35.txt
31st March 1999
I'd really appreciate your feedback on this FAQ - so mail me and tell me what you think of it, if it's been useful to you, or let me know of any specific problem you have where I may be able to help.
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