Crystal Umbrella

There has been a feeling of ‘at last’ amongst the contracting community following the news that IR35 will be reviewed as part of the coalition government’s review of small business taxation systems. This is to be the responsibility of the Office of Tax Simplification which is newly formed. There is a fear, however, that contractors are labouring under the misapprehension that IR35 is set to be abolished.

The newly appointed tax director at the Office of Tax Simplification, John Whiting, has been talking to Taxation magazine with the aim of correcting some of these myths which are flying about. Mr Whiting confirmed to the magazine that no decisions have been made at this juncture and they were keeping all of their options open. He did confirm, however, that the analysis of the wider taxation system will be the first step for the OTS.

This, of course, is not to suggest that there is no hope for the abolition of this contentious tax rule. Mr Whiting has acknowledged that the intermediaries legislation has been ineffective to date. He will be looking at the reasons why it did not work as expected, since its introduction was as a result of severe abuses of the previous taxation system. The fear is that these loopholes and subsequent abuse of the system would resurface if the rule was abolished without appropriate replacement legislation.

Mr Whiting has promised an all encompassing review of IR35 but contractors will have to wait until next year’s Budget for the conclusion to his analysis.

The Office of tax Simplification (OTS) has been set up to review tax systems and tax reliefs. It aims to put forward proposals to the government by the Budget next year for simplifying or replacing IR35 and other complicated and contentious tax rules. This has been supported by the REC who have written to the OTS to support plans to replace IR35 as this has been an area of particular interest for such REC groups as the Technology Sector Group and the Interim Management Association (IMA).

Chair of the Technology Group, Jeff Brooks, stated: “Over the coming year, the work of the OTS will have huge implications for the contractor market place. Specialised Recruiters in the IT and technology sector are in daily contact with contractors and have regularly flagged up the challenges that current taxation requirements create. We will be working constructively with Government and with the OTS to feed into the forthcoming reviews and to help streamline the current tax regime for those operating in our market.”

Meanwhile, IMA chair Paul Botting commented: “A review of IR35 is long overdue and will help to simplify flexible working options such as interim management. Interim executives and managers are key drivers for both growth and efficiencies and should not be stifled by an overly complex tax system. The voices senior interim managers and their providers must be at the forefront of the debate over the coming year.”

The working practices of the chief information officer at HMRC have been called into question. Deepak Singh was employed by Revenue and Custom’s for three years ending

in June 2009. However, at this point he became contracted to HMRC through his personal service company, Orwell Consulting Ltd, to fill the same position. His three month contract was worth approximately £50,000 per month which was equivalent to his previous annual salary.

HMRC’s accounts read: “For the period 19 June 2009 to 18 September 2009, £149,5000 was paid to Orwell Consulting Ltd for the services of Deepak Singh (a director of that company) who held the position of Acting CIO.”

This practice would allow Mr Singh to reduce his tax burden by paying himself in dividends and not paying NICs. Subsequently this would result HMRC reducing their overheads. Mr Singh, due to working through a personal service company, would be liable for corporation tax at the lower rate.

Speaking to Contractor UK, Qdos Consulting’s Seb Maley stated: “The Revenue had for some time been concerned about the hiring of individuals through their own service companies, so as to exploit the ‘fiscal advantages offered by a corporate structure. Employees were being handed their P45 on a Friday only to return to the workplace on the following Monday to do exactly the same job but, hey presto, as a contractor this time.”

He continued: “Consequently the contractor could now pay themselves dividends and, by so doing, avoid NIC [for both employer and worker] and reduce the [overall] tax burden.”

In a statement provided to Contractor UK, a former tax inspector commented: “The circumstances here appear to be a so-called ‘Friday to Monday’ (employee on Friday – limited company supplier on Monday) scenario, which was the main reason for the introduction of IR35 by the tax authority in the first place.”

The new director of the Office of Tax Simplification has confirmed that new measures to replace the contentious IR35 tax legislation will not be prepared and proposed until the Budget next year. Speaking to Contractor UK, John Whiting said that any new measures may have to take into account the amount each individual contractor earns. This could work in a similar manner to Australia’s former 80-20 rule.

Mr Whiting has accepted the unpaid tax director role for the OTS and his first port of call is to review tax relief and exemptions. At present many of the roles have not been filled within the OTS but when they are up to full complement a complete review of small business taxation will be conducted which will, of course, include the IR5 legislation.

Mr Whiting told Contractor UK: “”[IR35 is] a complex area – so I can’t promise immediate change or abolition. If [either were] easy to do, they would have been done already. We may have to go for more of the ‘80/20′ approach but let’s see where we get to. What I want…is a thoroughgoing review – not just another bit of sticking plaster.”

He confirmed that in reviewing IR35 he would need to look at why it was introduced, whether that need still remains and how it could be addressed more effectively. He will be reporting directly to the Chancellor of the Exchequer or the Exchequer secretary David Gaude.

He continued: “They will be able to accept or reject our reports because ultimately they have the responsibility for the tax system,” said Mr Whiting, pointing to the two ministers. But I would hope that if we do our job properly, our recommendations will be easy to follow; and if they do reject unreasonably, they will get lots of questions as to why.”

The hopes of the contracting community were dashed last week when the Budget failed to make clear any plans to abolish the contentious IR35 rule. Instead, the chancellor merely confirmed that a review would take place. However, the Daily Telegraph then published an interview with Mark Prisk, small business minister. The interview appeared to have taken place after last week’s Budget and suggested that IR35 “will now be abolished” without quoting Mr Prisk directly.

Many accountants have taken this article as a sign of success in the long running battle against the ‘deemed payment rules’. This is the reaction from Francesca Lagerberg, head of tax at Grant Thornton. Speaking to Contractor UK she said that “the hopes for abolition looks very much on the cards” since contractors have suffered under the IR35 rule for “over a decade”.

However, following this speculation it has now been confirmed that the Daily Telegraph interview with Mr Prisk was actually conducted weeks before the Budget and he did not make any confirmations that IR35 would be abolished. This confirmation was made when Contractor UK contacted his office and HMRC who confirmed that the government’s position on IR35 stands, i.e. a review will be taking place with no guarantee that the tax rule will be repealed.

HMRC commented: “The review of IR35 is linked to the proposed wider review of small business [tax]. Until the precise terms of reference are agreed, we cannot say much more.”

Managing director of accountancy and tax advice firm Brookson, Martin Hesketh, has given his reaction to Tuesday’s Budget.

Mr Hesketh stated: “The challenge facing George Osborne in the coalition’s first Budget announcement has been, to say the least, extensive. It was no surprise, with over £100 billion to re-coup, unemployment levels still on the increase and the post-recession economy more fragile than ever, the Chancellor positioned the Budget, in his opening statement, as an unavoidable one.”

With regards to the self-employed, the chancellor did commit to supporting UK enterprise, however cautiously. Corporation tax was reduced for small businesses and a commitment to review IR35 has already been given. Mr Hesketh does point out, though, that the extensive public sector cuts will have an effect on contractors currently working on public sector contracts and those looking for future work.

IR35 was not specifically mentioned in the Budget but Mr Hesketh believes that the review of the contentious tax rule will be placed within the overall review of Corporation Tax. Hesketh believes this is likely to take place over five years. The government is likely to consult with such professional bodies as PCG and APSCo to name but a few although clearer details on the review process will be made public in the autumn.

One of the most startling announcements in the Budget was the VAT rise from 17.5% to 20%. This will come into effect on 4th January 2011. The Chancellor is expecting this tax hike to recover £8.1 billion of the overall savings planned for this tax year. Capital Gains Tax is also increasing to 28% for high earners.

Mr Hesketh concludes: “The Chancellor made much in his speech of making sure that Britain was seen as being ‘open for business’ and supporting those that are working hard to grow or set-up new businesses within the UK, both of which will contribute towards getting the UK’s economy back on track. The flexible workforce will play a critical part in the recovery of the UK economy and on face value, the new coalition Government appears to be making the right noises in terms of wanting to genuinely understand the self-employed professional market, which I believe the industry should see as optimistic.”

PCG, the contractor group, has responded positively to the Emergency Budget delivered yesterday by the Chancellor, George Osborne. Speaking after the speech was delivered, managing director of PCG, John Brazier commented: “George Osborne delivered an intelligent and decisive Budget which has tried to tackle the historical deficit this country faces. He stated he wanted to create certainty and stability and we believe that many of his measures will do this. The roadmap for corporation tax and the laying out of income tax changes over the course of the Parliament are welcome and will help PCG members in their businesses.”

It was also welcome news to PCG, and all contractors, that the budget Red Book reiterated the commitment of this government to reviewing the IR35 tax rule. However, the group is concerned about the guaranteed public spending cuts which will become clearer when the spending review is published on the 20^th October 2010.

PCG Head of Public Affairs, Simon McVicker, said: ”We will only really know the severity of these public sector cuts when the spending review is completed in October but many public sector contracts may end due these cuts and at least in the short term Government contracts will be severely limited.”

Also commenting on the new Budget, Anne Redston from King’s College London gave her views to Shout 99. The Visiting Professor of Taxation stated: “This Budget has left freelancers and contractors relatively unscathed on the tax front. The promise of a small business review has been firmed up, and the Office of Tax Simplification is long overdue. In this Budget the Government has set out the big picture; now they can start colouring in the details.”

The Chancellor of the Exchequer, George Osborne, will deliver his first Budget later today. It is expected that he will detail the tax rises and spending cuts which the coalition government plan to initiate in order to recover the £153bn UK deficit. There are some specific expectations from this Budget which will have a direct impact on contractors.

IR35

Treasury ministers have already confirmed that more information of the fate of IR35 would be confirmed in due course. Ernst & Young, speaking to Contractor UK, commented: “The proposed review of IR35 is likely to take the form of a consultation document. While a simplification of the provisions would be welcome, there remains a significant tax disparity between carrying on business within a small company and being self-employed. As such, the tension between tax avoidance and administrative burdens is likely to continue at least in the short-term.”

Capital Gains Tax

The expected rise in capital gains Tax has already been confirmed by the new government. It will be increased in line with income tax. High earners will be subject to CGT at a rate of 40% but relief for business assets is expected to remain. The only factor which is, as yet, unclear is when the rise will be implemented.

VAT

Currently VAT stands at 17.5%, however across the EU the average for VAT rates are between 19% and 21%. It could be a possibility that the UK rate is risen to 20% in line with the rest of the EU. However, it is likely that such a rise would be phased in over several years.

Corporation Tax

In the Conservative manifesto they stated their commitment to reducing corporation tax to 25% while further reducing the small companies’ rate to 20%. Since the Liberal Democrats’ manifesto also discussed reductions it is likely that today’s Budget will announce these reductions.

NICs

Employers’ contributions to NICs for those earning £20,000 and above will increase by 1% as proposed by the previous Labour government. However, the NIC threshold for employer contributions is also likely to increase.

Cuts in Public Sector Spending

The Chancellor is likely to announce cuts of between £30bn and £60bn in the public sector. Wages will be frozen over the next year although many public sector workers are likely to face pay and pension cuts. Speaking to Contractor UK, managing director of Parity, Alan Rommel, stated: “ Big IT projects will be stopped where they don’t drive future efficiencies. Several bodies are scheduled to close where duplication occurs or integration can support savings, while projects that don’t demonstrate big returns may also be cancelled.

He concluded: “But hopefully the front line impact will be minimal and efficiency drives the savings. Potentially IT will be required to drive those savings and, if permanent headcount is restricted, the contract market could be required to deliver the skills to generate the savings.”

The Conservative and Liberal Democrat coalition Government is assessing the possibility of getting rid of what has been considered by many as a controversial and troublesome tax law, IR35.

The law, which was brought into being in 2000 by the then incumbent Labour Government, was enacted to enforce the payment of national insurance and tax by contractors. This is assessed on the earnings of those working within the contracting company if the role they carry out could be considered to be equal to that of employees of the client company, despite labeling themselves as contractors. The primary aim of the tax law was to curb the amount of people not paying the correct amount of tax (the belief was that it would bring in somewhere in the range of £220 million per year in unpaid taxes) – yet ultimately it caused confusion more than anything else, with some contractors having to pay vast amounts of tax unnecessarily and the Government collecting just £1.5 million ultimately.

Whilst there has been no official announcement that IR35 is to be scrapped the Government has said that it wishes to simplify taxation and introduce a scheme that helps small businesses and cuts the amount of red tape.

The new coalition Government published its programme last week, giving an abbreviated preview of the issues which the Chancellor will be addressing more fully in his Emergency Budget on 22nd June. The devil, of course, will be in the detail but it’s nonetheless possible to glimpse some key points. Here are some of the more prominent ones.

Whither IR35?

The notorious tax regulations embodied in IR35 came into force in 2000, when the previous government wanted to close a tax loophole. Prior to IR35, a number of individual contractors were paying appreciably less tax and national insurance simply by offering their services through a limited company. In effect, they were working full-time for a single employer but keeping much more of their income than an official employee doing identical work on PAYE. The aim of IR35 was to prevent contractors from setting up as a limited company whilst working long-term for the same employer.

However, the legislation soon ran into controversy, seemingly unable to distinguish accurately and consistently between bona fide contractors and those who were ducking and diving through the loophole. John Brazier, Managing Director of the Private Contractor’s Group (PCG), has condemned it as “a dreadful piece of legislation” which crudely caught everyone in the same net and encouraged HMRC to view every legitimate freelancer as a potential tax evader.

The new government’s published programme signals its intention to “review” IR35 and replace it with “simpler measures that prevent tax avoidance but do not place undue administrative burdens or uncertainty on the self-employed, or restrict labour market flexibility.” The news was quickly welcomed by PCG and many contractors will approve of the government’s plan to set up an Office of Tax Simplification. Whilst further details may become clearer in the June Emergency Budget, the issue is likely to go through a lengthy consultation process before decisions are finalised. Even so, proposals aimed at simplifying taxation matters for the self-employed should be cautiously welcomed at this stage, especially if they lead to the creation of better defined and fairer guidelines to avoid being deemed ‘employed’ when legitimately contracting.

Other issues of interest to many of our customers include the following.

Spending Cuts

By now it’s no secret that the coalition plans to curtail government spending by £6.2 billion within the financial year 2010 – 2011. The cuts will, the coalition insists, be directed at ‘non-front-line services’. Again, the Chancellor’s Emergency Budget will spell out rather more clearly just what this means.

Changes to Setting Up Limited Companies

The government’s bureaucratic simplification mission extends to this area, too. A new ‘one click’ method for registering companies is proposed, a measure which is likely to include all the labyrinthine tax aspects associated with new registration. On the topic of setting up and sustaining viable small businesses, there is also a commitment to devise assured means of keeping their life blood – the ready supply of credit from the banks – flowing efficiently.  To help facilitate this, a major new loan guarantee scheme will be considered.

Corporation Tax

Specifics are as yet still thin on the ground, but corporation tax rates are set to be reduced and the processes around corporation tax reformed.

Review of Capital Gains Tax

This one might cause a few sharp intakes of breath: a fairly hefty increase looks likely, but it’s not clear yet precisely how this will impact on different classes of investment or asset. What we do know is that the government plans to tax non-business capital gains at rates resembling those currently applied to income and that it believes there will be substantial exemptions for entrepreneurial business activities. Capital distributions made on the winding up of Limited Companies may well be affected by this.

Changes to National Insurance

The Conservative Party in opposition advocated an increase in employee National Insurance thresholds as a means of preventing the previous government’s proposed “jobs tax” and the new government is set to adopt this measure. National Insurance rates are also to be revised.

Increases to Personal Allowance Threshold

Lower and middle income earners are intended to be the chief beneficiaries of this measure. A generous increase in the personal allowance is planned for April 2011, paid from two sources: the extra revenues generated by increases in Capital Gains Tax for non-business assets, and the money that would have been used to fund the increase in employee National Insurance contributions. In the longer term, the government has set a target of £10,000 for the Personal Allowance.

VAT

Even though this isn’t specifically mentioned in the programme, it would be premature to suppose that no action will follow. Predictions from financial commentators are almost unanimous that VAT will rise to 20%, with some even expecting it to rise to 22%. The timing of any increase is unclear at present but as a rise in inflation is feared presently, some suggest that this may not be immediate. Others, however, expect the rise to be immediate – we’re simply going to have to wait and see on this one.

Bank Charges

A proposal which will be welcomed by millions is the government’s promise to implement much more robust consumer protections vis-à-vis the banks, including the abolition of egregiously unfair bank and transaction charges.

Equal Pay

Amongst a raft of measures aimed at actively promoting equal pay and removing workplace discrimination is a promise to extend to all employees the right to request flexible working arrangements. Business will be consulted on the best way of proceeding with this.

Watch This Space for News of the Emergency Budget

Readers can rest assured that Crystal Umbrella will be keeping a close eye on all Budget-related news, ensuring that you’re fully up-to-date with all the developments. As soon as it’s released, we’ll be sending you a summary of the Budget’s key points.