I'm noticing differing reactions and degrees of IR35-awareness on the part of agencies, from what Contractors are telling me. Some agents don't even know about it(!); some seem to think that the new requirements are still too vague to even consider taking them into account; some (I suspect) are too rigid to contemplate change; and one of my clients last week told me that an agent he was considering dealing with (one of the larger agencies) had claimed that any attempt to work around the new rules would be fraud! - clearly, nonsense! Against this background, there are a few agencies who are showing the flexibility to accommodate Contractors' concerns in a way which I believe will result in those few being those who have the best chance of surviving in the changed climate, and at the expense of those too rigid too change. These are times of opportunity - for some.
Let's start here: most Contractor-Agency contracts in their present form will fall foul of the new rules.
For as long as we have had a contracting industry, most Contractors have operated through their own limited companies, in order to avoid specific requirements for agencies to deduct tax and NI from all payments they make to individuals, regardless of whether or not the agency actually employs those individuals; so for tax purposes, it is the Contractor's company which is treated as the 'agency', resulting in the Contractor's company being paid gross the company we regard as the Agency.
Thus Contractors have learned to manage their own tax and business affairs: to pay themselves such salary as they choose, deducting tax and NI, and fixing that salary at a level that appeared appropriate, after taking into consideration other commercial factors affected by the salary level, such as mortgageability, and the limits on contributions to approved pension schemes; to cover business-related expenses from their companies; and to either retain any residual profit in their companies (either for the future, or for deployment in other business ventures), or to pay it out to themselves as dividends. It is a structure which has had the side effect of allowing UK industry to benefit, both from a large pool of skilled individuals prepared to work flexibly, and from the numerous spin-off businesses that many Contractors have started, once they got to grips with the idea of running their own companies.
Times change, and all know by now that new rules fundamentally affecting the tax and NI position of Contractors will come into force with effect from 6th April 2000. These new rules will result in the whole income (apart from a 5% allowance for general overhead) from many types of contract (see my Freelance Informer articles of 29th October and 26th November) being subject to tax and NI at the highest rates, as if it were salary - and subject only to the same very limited tax deductions that a conventional employee can set against tax; these are:
Training, in particular, will NOT be deductible (http://www.inlandrevenue.gov.uk/ir35/pmgltr.htm) - the government expects 'Individual Learning Accounts' (to be introduced April 2000) to be used - it remains to be seen just how useful these will be; I have my doubts.
Two things will therefore go, for income from contracts falling foul of the new rules:
So what actually will the cost be? Let us take a Contractor whose rate is £50 per hour, working 40 hours per week, for 48 weeks a year, and taking 4 weeks annual paid leave as required under the Working Time Directive. Under the National Minimum Wage (NMW) rules, (s)he is required to be paid a minimum salary of £3.60 per hour, which over the year comes to £7,488 (note that you cannot waive this right to NMW - your company is required to pay it, you as a director of your company are required to see that it does so, and the Revenue have the right to enforce this).
Assuming there are no employee-deductible expenses, no approved pension scheme contributions, and £5000 of other annual business expenses, then that Contractor can end up at present with £61,637 net in his/her pocket, after payment of the £5,000 business expenses. Under the new rules, I calculate that (s)he will end up after expenses with £50,607 - a difference of £11,029 (17.9%) in additional tax and NI.
If on the other hand the Contractor has a contract which is outside the new rules, but decides instead to take no more than the net £50,607 out of the company, then I calculate that (s)he will be left with an additional £14,200 after-tax retained profit in the company; or £17,100 before tax, for payment of other business expenses.
It is a well-established legal principle that every person is entitled to arrange his/her affairs in such a way as to minimise the amount (s)he pays in tax, provided (s)he does so legitimately. I firmly believe that a high proportion of the contracts in this industry cover positions which are quite capable of being contractually defined so as to fall outside the scope of the new rules, and that it will therefore be very much in the interests both of Contractors and agencies to negotiate contract terms which, so far as practicable, do so.
10th December 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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