Crystal Umbrella

In a survey of small business owners, which include contractors owning Limited Companies, The Federation of Private Business (FPB) has discovered that over half of them (57 per cent) are prepared to pay more tax in exchange for a simpler and fairer tax system.

Of those polled, 50 per cent said that they would pay more under a simplified tax regime provided it prevented tax avoidance by their bigger competitors. The latter often have the resources to exploit tax loopholes geographically. Almost half of them said they would tolerate higher tax payments if legislative red tape were reduced.

The FPB’s Chief Executive Phil Orford noted that the cost of complying with the UK’s labyrinthine tax system is so high – in terms of time, money and the vagaries of IR35 legislation – that many small business leaders are of the view that a little more tax would be a “price worth paying” if the system were to be simplified. He added that if the government is serious about its commitment to stimulating small business growth, a streamlined tax administration should be a top priority.

Mr Orford was scathing about current tax loopholes, which hugely favour bigger firms. Larger retailers can, for instance, set up shop in places like the Channel Islands, where they proceed to deliberately undercut smaller shops and internet retailers, a practise which leads to flagrant tax abuses and distorts competition. The recent plans announced by HMRC to clamp down on tax avoidance fall short in several areas, including this one.

Reforms to incentivise small business growth are “desperately needed,” he went on; small firms need to invest their time and money in expansion and future planning rather than in an unwieldy and unfair tax system.

Contractors have been vocal for many years now regarding the IR35 tax rule and their wish for its abolition. Now the Institute of Directors have joined the campaign for the intermediaries legislation to be repealed.

Handing a paper to the Office for Tax Simplification (OTS), the IoD referred to IR35 as “a serious problem”. They pointed to investigations which find contractors to be inside IR35 and the subsequent effect on organisations who have hired them, when the taxman comes knocking for PAYE and NICs. It is the belief of the IoD that tIR35 should be replaced with a specific test for contractors based on their working practices. They also believe an initial screening test should be introduced.

Speaking to Contractor UK, Richard Baron, head of tax at IoD commented:
“We want to take as many businesses as possible out of the scope of the replacement for IR35 in order to minimise the hassle for businesses. If a large number of businesses could take one look at an initial screening test and know straight away that they do not need to worry [about the contractor’s IR35 status], that would be very helpful.”

Speaking about the introduction of a test for contractors, the group told OTS: “The test would however need to be one that would allow most contractors to be confident of their likely status for a tax year, or for an engagement, while the year was in progress or before starting the engagement. Otherwise they might not put enough money by to cover tax and national insurance (NI) liabilities.”

IoD concluded their submission by stating: “The managed service companies’ legislation, which was necessitated by the impracticality of applying IR35 on any large scale, has tackled the bulk incorporation of whole workforces. There is a case for some replacement for IR35… [but the legislation has] has turned out to be a bad solution to a problem that has shrunk”.

The investigation into the effectiveness of IR35 and possibilities for its replacement is still at the forefront of most contractors’ minds. During question time in the House of Commons last week, David Gauke, Treasury Minister, confirmed that the Office of Tax Simplification will have submitted its report to the Chancellor before the Budget next year. This means the future of IR35 will be included in next year’s Budget.

This confirmation came as Mike Freer MP questioned the steps being taken by the government to keep to their promise of simplifying the current taxation system. Mr Gauke responded: “The Government are committed to simplifying the tax system. To help to achieve that, the Government have established the independent Office of Tax Simplification. Business and tax professionals have also consistently pointed to the way in which tax policy is developed, legislated and implemented as a contributing factor to overall complexity. We published a discussion document alongside the June Budget setting out proposals for a new approach to tax policy making.”

Mr Freer then asked specifically about the progress of the OTS investigation into tax reliefs and IR35. Mr Gauke responded: The OTS is looking at two areas. One is reliefs and exemptions, and although the timing of the publication is to be finalised and that is a matter for the OTS, there will be an interim report, I believe in November, on this area. With regard to the reform of small businesses, including IR35, the OTS intends to report in time for the Chancellor to take into account its views in preparation for the Budget.”

Contractors who work through umbrella companies instead of their own Limited Companies may be relatively safe from unwelcome entanglements with IR35 legislation – but this doesn’t necessarily mean that they’re completely out of the HMRC frying pan. With deficit reduction being the superordinate priority of the UK’s coalition government, HMRC is making it plain that it intends to collect every penny of tax from the citizenry that it can find.

Anyone who has held two or more jobs during the course of a single tax year could well attract the scrutiny of the tax man, which means that agency temps and employees of umbrella companies may find themselves the focus of revenue raising attention. It’s in the nature of contractor work to move from project to project and HMRC’s decision to use this particular criterion as an “alert” signal is leading to some anxiety amongst the flexible workforce.

Things shouldn’t be too bad if your umbrella company has maintained your paperwork properly – you should, if required to do so, be able to demonstrate fairly easily that you’ve paid all due taxation through your PAYE umbrella as well as all necessary national insurance contributions. Whilst this may not spare you an unwelcome phone call or letter inviting you to attend an HMRC interview, you probably only need to worry if your company has been a little on the slapdash side in its financial record-keeping. This is a little more likely to be the case where record-keeping systems are manual rather than automated.

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.”