Crystal Umbrella

The Office of Tax Simplification’s Small Business Tax Review is published today and contains two key recommendations for reform, which have relevance for contractors working for either umbrella companies or limited companies.

Acknowledging that IR35 legislation proved to be the “thorniest issue” raised by small business representatives across the UK during the OTS roadshows, the review also notes that “no one method of reform currently commands universal support.” Outright abolition would also require “underpinning by a much better quality of data than presently seems to be available.”

The two central pillars of the review are structural reform of the current tax system by integrating National Insurance Contributions and Income Tax, and the introduction of a radical new approach to taxation for the smallest unincorporated businesses.

Prior to structural reform of taxation, which the OTS believes will remove the need for IR35, the review recommends two alternative approaches: suspending the legislation with a view to permanent abolition (using the suspension period to investigate behaviours and costs) and preserving it unchanged but improving its administration by HMRC.  But there is also a third alternative, which may interest the Chancellor – the introduction of a new “business test” aimed at radically reducing the size of the population currently caught by IR35 legislation. The effect would be to exempt large numbers of individual contractors from the worry of an IR35 investigation.

Other areas for reform include simplifying the VAT system for small businesses undertaking international activities, improving the capital allowances regime and improving HMRC administration.

We’ll bring further details of the review in subsequent news reports.

Happily, for contractors working through umbrella companies, the frustrating issue of tax calculation is taken care of by the agency. But PAYE umbrella freelancers might spare a thought for those poor souls who have to wade through self-assessment tax returns every year; new evidence suggests that by being unaware of tax efficiency measures, Britons are handing HMRC an astonishing $13.5 billion each year in unnecessary payments.

The findings come from a study by the financial advisory service, unbiased.co.uk, and reveal that many UK workers are nowhere near as tax efficient as they might believe. Women emerge as the most susceptible to what the organisation calls “tax apathy”, with 91 per cent of those polled failing to take any steps at all to lower their tax liability. Possibly more worrying are the 45 per cent of respondents who believe they already are being as tax efficient as possible, when the figures strongly suggest otherwise.

According to unbiased.co.uk’s Chief Executive Karen Barrett, large amounts of money are being blithely handed over needlessly to HMRC across all tax categories. A little tax planning is all it would take to prevent this. Ms Barrett noted that while more and more consumers will save money by using online moneysaving websites or by switching utilities provider, they appear to be relatively indifferent about losing money through excess tax. In fact, they are likely to save more money annually through tax efficiency awareness than by these other measures.

The study coincides with comments by the Conservative MP John Redwood, about the previous government’s tax policies. Writing in his online diary, he claimed that thirteen years of punitive clampdowns and increasingly complex legislation by Labour had blurred the distinction between tax evasion, which is illegal, and tax avoidance, which isn’t.

One of the major issues influencing whether prospective contractors chose to operate through umbrella companies or their own limited companies is the thorny issue of IR35 legislation. Introduced by the previous Labour administration in 1999, it was created in an attempt to prevent tax avoidance. In reality, because of the complex and ambiguous ways in which the distinction between employed and self-employed statuses are cast in the legislation, many freelancers have been subject to distressing and time-consuming IR35 investigations by HMRC, with the prospect of facing heavy penalties if deemed to be in disguised employment.

PAYE umbrella contractors have largely been spared these ordeals, with their status clear and their tax calculations handled by the agency. As is well known, however, the Office of Tax Simplification (OTS) was set up by the incoming Coalition government last year to consider reform of all areas of tax pertaining to UK businesses. Reform of IR35 was, from the outset, one of its principal targets.

OTS Director John Whiting has just announced that his organisation will provide a report on its review of UK taxation ahead of the March 23^rd Budget. However, he warned that contractors seeking an immediate reform of IR35 will need to be patient – proposals for a successor to the widely disliked legislation will need “bottoming out” time after the budget to assess their implications.

The OTS final report is due in the summer, and Mr Whiting was clear that he wishes to come up with true improvements by then on what is broadly considered to be an excessively burdensome regime.

Whilst contractors working for umbrella companies will have had their tax automatically calculated and paid, those who file self assessment returns should be on the lookout for a new e-mail scam, according to a warning issued recently by HMRC.

There has been an increase in the use of phoney emails disguised as official HMRC communications in recent weeks, this time advising people that they are entitled to a tax rebate.  But the first thing to note is that the real HMRC would never use email to inform taxpayers of matters such as this.

The fake emails contain a range of ruses aimed at getting people to divulge sensitive personal information.  One invites individuals to visit a webpage to verify their banking details; another claims that lottery winnings, seized goods or inheritance money will be paid as soon as the necessary personal banking data is supplied. Yet another invites people to download an attachment which ostensibly requests a refund through PayPal. In addition, HMRC warns, several such scams have emerged via SMS – recipients of these messages are asked to call a number in order to “claim” their “refunds.”

All are phishing exercises and should be avoided at all costs. If anyone receives such a message, HMRC requests that they forward it immediately to phishing@hmrc.gov.uk and then delete it without delay.

The timing isn’t accidental – the self assessment system inevitably results in many freelancers completing their returns at the eleventh hour (or later). Scammers tend to exploit flurries in activity to provide a convenient cloak for their nefarious deeds. Unsuspecting freelancers may be expecting all manner of communications and reminders from HMRC at this time of year, rendering fake tax-related emails more plausible.

HMRC will never contact you via email to request personal information or update you on personal tax matters.

Whilst many in the UK’s freelance community work through umbrella companies or limited companies, some, especially in the construction industry, are paid through specialist payroll companies. However, the darker side of payroll outsourcing has recently come to light, leading the UCATT trade union to call on the government to launch an investigation into malpractice. It appears that a small number of payroll companies had been complicit in promoting fake self-employment in the construction industry. As a result of the payroll chicanery, construction managers were able to rehire redundant staff to do the same work as before, only this time minus all the rights and protections they had enjoyed as employees.

The Freelancer and Contractor Services Association (FCSA) has been quick to respond to the news, with the organisation’s chairman, Stuart Davis, issuing a robust condemnation of the practise. However, he also pointed out that not everyone on an agency payroll need be worried – most payroll companies are completely ethical. Those that adhere to the FCSA’s Code of Conduct, which unambiguously prohibits activities such as this, are all fully complaint with the law and can be trusted by both contractors and employers seeking freelance staff.

The Recruitment and Employment Confederation (REC) also maintained that the status of sub-contractors in the construction industry was carefully verified by close co-operation between HMRC and construction companies. The chair of the REC’s construction division, Simon Noakes, said that he fully supported the effective implementation of currently existing regulations, but maintained that it would be an exaggeration to conclude that large numbers of contractors were being forced into phony self-employment. There are many workers in the construction industry who willingly chose to work as contractors.

It appears that some umbrella companies have been paying their workers at rates that fall below the National Minimum Wage (NMW), but topping their income up through expenses schemes. HMRC has taken a dim view of this practise and has just issued a warning that it plans to identify all businesses that seek to “circumvent the NMW.” The department goes on to warn that “appropriate action” will be taken.

In a nutshell, when expenses are used in this way, the schemes are “contrary to the will of Parliament,” according to HMRC. The department will be targeting umbrella business models that pay subsistence expenses rather than bone-fide travel expenses, but other practises will also be penalised. These include the under-recording of hours worked, falsely designating workers as directors and making “holiday pay adjustments.”

Employment businesses and umbrella companies that fail to comply with HMRC guidelines on NMW will also come under scrutiny for tax compliance. Any non-compliance identified in this area could result in the revocation of company dispensation as well as the repayment of arrears of tax and National Insurance with interest, and quite possibly penalties as well.

Contractors who suspect that their umbrella company is operating schemes such as these are best advised to switch to a compliant PAYE umbrella service (such as, for instance, Crystal Umbrella) without delay. A gimlet-eyed tax inspector could well be about to pay a visit very shortly to those businesses which fail to comply with HMRC’s tax and NMW requirements.

A new amendment to the Income Tax Earnings and Pensions Act of 2003 will close a loophole which some freelancers on the contractor payroll may have used to avoid or defer income tax or National Insurance Contributions (NICs). Henceforth, HMRC intends to tackle all arrangements, including trusts, that are aimed at offering tax-advantaged alternatives to saving beyond the allowances permitted in a registered pension scheme.

The government has been alerted to the fact that some third party arrangements seek to disguise remuneration by claiming that an employee has no legal right to a sum of money under the structure of the agreement, when in fact he or she may be enjoying the full benefits. The targeted arrangements seek to argue that NICs and income tax will only be due on the sum provided during the employment period, rather than on the full value of the assets.

The new legislation will come into effect on 6th April 2011, and aims to ensure that – other than specific exemptions – all rewards, recognitions or loans earmarked for an employee’s benefit, whether current, former or prospective, will be eligible for income tax and national insurance contributions. The exemptions include registered pension schemes, ordinary commercial transactions and approved employee share schemes. The HMRC website contains an explanatory note as well as details of the draft legislation.

Contractors working for a PAYE umbrella company may be unaffected, but other freelancers may wish to consult a qualified contractor accountant for advice.

Many American and European companies have moved their bases to India in recent years in a bid to reduce costs. However, proposed changes to the taxation system in India could force them out.

Currently India has a rather complicated tax system. The Indian government has now tabled sweeping reforms which could seriously impact on any businesses working from their country. Part of the new reforms would consider all companies with a “management presence” in the country as being Indian tax residents. This would, therefore make such companies liable to taxation at a rate of 25%. Such reforms could result in a move away from outsourcing IT services to the sub-continent which has been such a prevalent trend for many years now. Most larger companies have an IT presence in India, many of whom choose to have software developed there as it is considerably cheaper than in the UK.

Commenting on this news, Pranay Satra from Ernst & Young stated: “The Indian Government’s proposals are immensely ambiguous. They could have a serious dampening effect on foreign investment.” Pranay also commented that such reforms are likely to ‘spook’ foreign companies.

Recently, many UK-based companies have come under fire for taking advantage of the ‘intra-company transfer’ system by displacing British workers in favour of cheaper workers brought in from India.

It would appear that India is now looking to benefit from their position in this industry.

Satya concluded: “As India has become more globally integrated, tax officials have taken radical new steps regarding global transactions – even those with only an indirect effect on India.”

Alistair Darling has announced plans to withdraw ‘equitable liability’ with effect from April 2010. Equitable liability allowed tax demands to be scaled back during periods of illness and bereavement. This move by the Chancellor is expected to have implications for self-employed people and the elderly.

The equitable liability concession applied to corporation and income tax. It allowed HMRC to use this rule as a safety net against bankruptcy when taxpayers had missed their deadlines for tax filing and appeals. HMRC would usually apply these concessions when the assessed liability is more than the tax that would have been charged if the return had been filed on time.

Keith Gordon, a barrister who is petitioning against the abolition of this concession said, “HMRC proposes to abolish this practice. This means that where HMRC have estimated tax liabilities and taxpayers have not lodged a formal appeal within the statutory 30-day period, HMRC will now pursue those amounts even where taxpayers can prove that their real tax liabilities are less.”

Under the concession HMRC did not pursue the difference between the liable amount and the revised amount although the legal tax liability was not reduced. There must be evidence to support the reduced amount due.

Tax officials have long questioned the need for this concession to remain. They argue that taxpayers are awarded many opportunities to tell HMRC if a tax bill is incorrect. However, Mr Gordon is counter-arguing that the removal of this system will lead to injustices.

He said, “This will expose many of the country’s most vulnerable taxpayers to debts that they cannot afford and do not actually owe. HMRC should not aim to collect more than the right amount of tax.”

While this rule has been changed to ensure that people are not paying too little tax, commentators have stated that HMRC should also be legislating to ensure that people do not end up paying too much.

HMRC have said that they will still accept late returns in exceptional cases. Speaking in an online statement they said, “In such cases HMRC will accept the late information and adjust the liability accordingly. We will also continue to help taxpayers who have difficulty paying what they owe and in appropriate circumstances allow payment to be made over a period of time.”

April 2009 marks the month that will make effective several changes in the powers of Her Majesty’s Revenue & Customs. These changes will include increased freedom for HMRC to investigate individuals and contractors, as well as businesses. There will also be changes to several tax laws.

Experts, who stress the importance of the taxpayer understanding the eventual implications of such changes, consider that the increased authority of HMRC to investigate people potentially in violation of the tax rules is a very significant change. Simon Wilks, tax partner at the firm Big Four, told Witan Jardine: “No one can afford to stick their head in the sand and think that these changes won’t impact them.”

In addition to these changes several new amendments become effective during the first week of April. These are intended to improve how consumers and businesses work with the governing body. A new two-tier system of tax tribunals will replace General Commissioners and Special Commissioners, as well as the VAT and Duties Tribunal. This set of tax rules will be applied across PAYE, VAT, income tax, capital gains tax and corporation tax; effective from April 1st.

From April 6th all employee starter and leaver notifications, as well as other pensions notifications, will have to be filed online by employers with 50 or more employees. HMRC permanent secretary for tax, Dave Hartnett, told Money Marketing, “These initiatives will provide businesses with more consistency, certainty and faster on-line processing of key documents.”