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| CURRENT SECTION :: Money | UK's most visited IT Contractor Site - 250k unique visitors March 2008 |
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Background In the 2006 Budget, under the banner of “tax motivated incorporation” the Chancellor announced he would bring forward discussions around the tax and NICs systems, with a particular focus on how best to tackle disguised employment via Managed Service Company (MSC) schemes. This statement simply reaffirmed the Government’s long held opinion that only those individuals who are genuinely in business should be able to make use of the tax advantages of working via an incorporated business. The tax advantages were introduced to encourage entrepreneurs rather than to allow individuals to avoid paying their proper share of tax. The 2006 Pre-Budget Report (PBR) paper entitled “Tackling Managed Service Companies” (TMSC) set out the proposed steps HM Treasury (HMT) intended to take to ensure the collection of tax and NIC and noted the start of a consultation period ending 2 March 2007, during which time HMT invited comments about how well the proposed legislation defines and targets an MSC, a scheme provider and whether the proposed transfer of debt provisions can be applied correctly. HMT’s view of the industry The TMSC document summarises the issues HM Revenue & Customs (HMRC) have experienced in trying to police compliance with existing legislation for contractors working via corporate structures, such as composite companies and Managed Personal Service Companies (MPSCs). Basically proving that a contractor is caught by IR35 has been very time consuming and far less successful than hoped. It also notes the frustrations of HMRC where, as part of any review, underpaid tax/NIC is identified but there has been an inability to collect the sums due, either because the companies have no available cash/assets to meet the liabilities or because, in more extreme cases, the companies have been liquidated and the contractors within them have been switched to other “new” corporate structures to start afresh. This is known as “phoenixing” and is often on the advice or instruction of a scheme provider. These frustrations set the tone of the TMSC document. The industry’s response Not surprisingly, given the tone of the document, its objectives and the proposed legislation drafted to support the enforcement of the new rules, there has been a large volume of comment and opinion from contractors, agencies and the service providers. The most contentious issues seem to be: - HMT’s belief that a contractor working through an MSC cannot be in business on his own account. The view is the same regardless of whether the contractor is inside or outside the scope of IR35. It is not the contractor’s individual circumstances that are key (as under IR35) but his connection with an MSC scheme provider - HMT’s failure to recognise that there are compliant service providers (and contractors) in the industry who are impacted to the same degree as non-compliant service providers (and contractors) - HMT’s reluctance to define “control” – this is discussed later - the very short window to allow any representations to be made and for any changes to be incorporated, following the completion of the consultation period and the start of the new tax year on 6 April 2007. The legislation itself: control To fall outside the proposed legislation a contractor must be able to demonstrate that he/she is “genuinely in business on his/her own account”, rather than simply passing the IR35 tests. HMT would regard a contractor who exercises “financial and management control” of his own company as one who is in business on his own account. Contractors working via a managed company structure are seen as having the actual financial and management control of the company undertaken by a third party. It is a significant factor in the eyes of the HMT that a contractor who benefits from working in a limited company should be aware of the financial risks of being in business and have responsibility for the running of the company – it is not enough to simply have a shareholding and pass the financial and general management of the company to a third party. The third party, or “scheme provider”, is often a business, typically a composite, which provides various levels of support services to a large number of contractors including: 1. Control of the shareholder structure 2. Provision of a company director 3. Formation of the companies 4. Accounting and payroll services 5. Invoicing services 6. Preparation of personal and corporate tax returns 7. Companies’ compliance activities HMT have acknowledged that providing some of these activities does not necessarily constitute “control”, but providing all of these services is likely to constitute control, resulting in the company receiving the services becoming an MSC. The provision of some of these services by a provider (such as an accountant or payroll bureau) would not necessarily mean the company used by the contractor is an MSC. It is the “de facto” control of the company through which the contractor is working which HMT believe differentiates an MSC from a PSC. This issue of “control over the finances or general management” is the key factor in determining whether a contractor is within an MSC or a PSC. However, instead of using existing legislation (with case law to provide clarity) to define “control” the TMSC document provides that control will take its “general meaning”. This may be a deliberate move on the part of HMT to enable HMRC to cast its net as widely as possible and to ensure a cautious approach for any contractor service provider who wishes to be a compliant business. The downside for HMT is that HMRC will not be able to say with certainty whether a contractor’s company is an MSC until the case is decided in court. In respect of looking at control, noted below are some frequently asked questions about whether the provision of certain services would constitute control being passed to the service provider and therefore the contractor company becoming an MSC: Are individual company bank accounts necessary? The TMSC document notes that the use of single bank accounts in the name of the service provider, used for collecting and holding of contractor company monies, is an example of the service provider exercising financial control. Therefore, going forward, individual company bank accounts with the company director (the contractor) authorising transactions on the account is advisable. Does the provision of accounting/payroll services suggest control? The outsourcing of services such as accounting or payroll to a third party is noted in the TMSC document as an example of services which can be completed by someone other than the contractor’s company, without this constituting financial or general management. This will allow contractors to appoint third parties to complete certain task without relinquishing the control of the company. Can a contractor outsource the completion of tax returns? As with the outsourcing of accounting and payroll services, the simple act of requesting a third party to provide assistance in the completion of personal and company tax returns does not constitute control being passed from the contractor to the third party service provider. Does the holding of tax liabilities by a third party to be paid over to HMRC constitute control? One of the HMT’s concerns noted in the TMSC document is the inability of HMRC to collect underpaid tax/NIC liabilities. If the industry is forced to change from the third party service provider holding tax remittances (PAYE/NIC, CT and VAT) (in an account until the due date for payment) to the contractor companies personally holding the monies would in reality increase the risk of non payment of these sums. I do not believe that HMT intended an increased risk of tax/NIC being lost and the industry has asked for guidance on this point. It is difficult to imagine HMRC arguing that holding tax liabilities for HMRC constitutes control since the effect of running this argument would be for service providers to simply transfer the monies to the contractor company’s bank account. From a legal perspective, if the contractor company elects to be prudent, and via a direct debit mandate, permits a third party service provider to deduct amounts equal to its tax liabilities to a separate account, this would not seem to constitute a loss of contractor control. There are a variety of questions around how this new legislation will impact on the contractor population and the above are just some of the most common queries currently being raised. Whilst the TMSC document noted that specific guidance would be provided for individuals and service providers affected by the changes, it has yet to be published. This gives little time before the beginning of the new tax year for all concerned to read and understand the issues. Debt transfer provisions The legislation is given teeth and reinforced by the introduction of the “debt transfer” provisions, whereby any contractor who works via an MSC and is not complying with the new legislation can be personally liable for any underpaid tax/NIC liabilities. The debt transfer rules also permit HMRC to seek monies from any third parties who have directly/indirectly benefited from the provision of services via an MSC. The transfer of debt provisions will ensure any scheme providers and organisations (agencies or end users) who have instigated the use of an MSC and benefited from such an arrangement can theoretically be pursued for any unpaid PAYE/NIC debts of an MSC. The next stage We have now had considerable opportunity to review the draft legislation and been involved with appropriate experts in order to understand where the new rules are likely to impact and whether contractors engaging these services are caught as MSCs. In addition we have participated in the consultation process and therefore, based on our experiences and findings, we are now in a position to add some further comments on this emotive area. HMT would like to introduce a simple test of “being in business on your own account” to complement the existing IR35 legislation. This is aimed at those contractors who HMT believes do not understand the corporate structure through which they are currently working, such as a composite company arrangement, and do not have any responsibility for the running of the company in which they work. The difficulty for HMT has been to articulate what “being in business” means and at present it is stuck with the control test. HMT’s intention to force contractors into corporate structures where tax and NICs are fully deducted is not going to happen. If the legislation is enacted in its current form HMRC are going to have as difficult job in enforcing the new legislation and proving “control” as they currently have in proving “status” under IR35. It is the control test that will be the difficulty for all affected parties. HMT believes that the majority of contractors in composite structures are not “in business”. The fact that many composite providers are simply moving their contractors to PSCs and advising them that they will be compliant with the new legislation and “in control” proves how difficult HMRC’s job is going to be. Can contractors still receive dividends? Throughout the period from the PBR to date, HMT and HMRC have accepted that there are contractors who are in business on their own account. These contractors can receive dividends and not be subject to additional NIC or tax on the dividends. These contractors must work through PSCs and pass the “control” test. We should not forget that most of the contractors working via MSCs are regarded by the Treasury as not being in business on their own account. Even if they move to PSCs and are found to pass the “control” test this may only be a temporary solution since HMT will no doubt revise the legislation if it is found not to work as HMT intended. It is important to highlight that where a contractor can demonstrate they are in business on their own account, this does not automatically mean the contractor is working outside of IR35; there is still a requirement to consider whether the IR35 legislation applies to any relevant assignments undertaken. Conclusion The PBR has highlighted that the Government has a strong desire to ensure that individuals should only benefit financially from working in a corporate vehicle where they are taking the relevant risks of running a company (ie being in business on their own account). The current prevalence of managed service solutions where the contractor effectively does not control their own company (or even understand how the company operates) is, in the eyes of the Treasury, unacceptable avoidance of PAYE and NIC. Our understanding of the market position is that there will be a great number of contractors currently working in MSCs moving across to “PSCs”, which will create increased pressure on the various administrative arms of the Government as the new companies are formed, register for VAT, corporation tax and PAYE. Contractors who are genuinely in business on their own account should carefully consider whether the advertised “PSC” could be viewed as an “MPSC” – the old adage of “look before you leap” has never been more appropriate. It is apparent that those affected in this sector are going to have to think on their feet, as it is quite clear that definitive guidance from the authorities is not likely to be forthcoming before the legislation is planned to start. PayStream provides support services to contractors wishing to work via PSCs. Previous Page
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