Why the UK should form a Freelancer Limited Company

It started out as an idea on the fringe of the Labour Party conference. It was then picked up and made a proposal by IPSE, the trade body for contractors, formerly the PCG. It’s now commanding column inches in the national press. The Freelancer Limited Company (FLC) is indeed gaining ground, writes Philip Ross, a founding member of PCG.

The FLC – questions abound

But how would the FLC work in practice? Who would use it? And what would be its advantages and limitations? Before offering answers to these questions, I will explore a more basic but fundamental one – does the UK actually need a FLC?

As the lead author of a report which put forward the FLC as one of its four key recommendations, it’s unsurprising that I say ‘yes’ -- the nation is indeed in need of a new form of a limited liability company for a single person trader who is self-employed.

‘The forgotten middle’

To show you why, let’s firstly take a step back and glance the bigger picture. The UK is facing a general election which almost certainly is not going to be the two-way fight we traditionally witness. This means that politicians are going to have to start reaching out to more than just their core voters, growing numbers of whom are self-employed.

In policy terms however, freelancers are often forgotten. The focus instead, so far at least, is on corporate executives faking self-employment to avoid tax, or on those forced into self-employment by unscrupulous companies hoping that both tax and employment rights can be dodged. For a long time though, there’s been a split between those exploiting the system and those being exploited by the system. In between these two extremes is the genuine freelancer and contractor market, less the squeezed middle; more the forgotten middle.

If the contracting and freelancing markets are the forgotten middle, the irony is that the few occasions that they have been noticed by Whitehall have resulted in poor outcomes for workers at both ends of the scale – well-paid independent professionals, such as IT contractors, and precariat workers, such as lower-paid freelancers.

The biggest proof of this is IR35, which from its passing into law in 2000 has demonstrated a total misunderstanding of how the freelancing market works, believing as it does that all freelancers incorporate into companies simply to avoid tax. Although HM Revenue & Customs now admits that PSCs aren’t primarily driven by tax factors, attempts to tinker with the Intermediaries Legislation seem doomed to failure, and the recent announcement that Business Entity Tests are to be abolished is a case in point.

Untangling the Gordian knot

But the tax department hasn’t really learnt. Whether it’s IR35 more than a decade ago, or the onshore intermediaries legislation we've recently been served up, the truth that these legislative sledgehammers speak of is simple. It is that temporary workers, precariat workers, those in forced self employment, those faking self employment for tax avoidance and those in genuine self-employment are all linked together in a mess of a Gordian knot.

Well, the FLC is a creditable way to begin untangling it. The make-up of the proposed structure follows, as does the answers to questions I posed at the outset, but it is firstly important to note the roots of the FLC.  

Cranfield University’s Andrew Burke, who contributed to the report I wrote recommending the FLC, has made the important observation that independent freelance professionals, such as IT contractors, are different types of economic agent whose goal isn't to be the next IBM -- just as the corner shop doesn't always inspire to be the next Tesco. His finding, which is reinforced by similar studies by Kingston University, Demos and the RSA, underlines the fact that freelancers are different types of small business.

In particular, they tend to be single-person businesses, often have only one client on the go at a time and they can't always find an equally skilled substitute to fill their boots on a sick day -- but that shouldn’t make them any less genuinely self-employed.

Cue the FLC, a single-shareholder-only structure, run by the key income generator who has no need to have multiple/concurrent clients on the go, and no need to specific a substitute in its contracts (of which those lasting less than seven months would be automatically deemed genuine freelance).

The Freelancer Limited Company – who, what and how?

There would be a freelancing registrar that FLCs would need to join. To register, the freelancer would have to nominate themselves as the FLC’s sole operator (the single shareholder, so not a spouse) and agree to a fixed but fair salary-dividend split. In return, registered FLCs could be excluded from some of the more extreme issues of IR35, such as the need to supply a substitute and the need to have multiple clients on the go. The other advantages of a FLC include limited liability status, simplified accounting and the ability to register for benefits between contracts. FLC owners would also be able to gain tax credits for sickness, maternity, paternity and other leave. Some other traits of a limited company would be shared too, such as the ability to pay expenses (including for training) and employ staff.

There would still be a requirement to demonstrate that the contract which a FLC has with a client is not one of employment. But new legislation is not needed; HMRC would just have to update its guidance. And there would be no obligation to use a FLC, a contractor could ignore it and continue to operate as an ordinary limited company and face down IR35 as normal. Precariat workers might use a FLC as well, especially as tax credits, benefits and welfare support between contracts would be part of its make-up. But these lower-paid freelancers are regarded as eventual not immediate users of a FLC, as the structure would need to have safeguards built-in to prevent these sometime vulnerable workers from being forced into it.

Final thoughts

My firm belief is that a FLC would offer more certainty over status for both tax and employment purposes. As it could still be a limited company, it would continue to interface with existing tax and employment law and regulations (such as Section 44 and other agency workers’ rules).

The argument that people become self-employed, contract or freelance not to save tax, but rather for business, economic, or professional reasons needs to be won, not just recognised. Politicians should want to ensure that the drivers for freelancing and contracting on both sides of the equation (for freelancer and for client) are economic, business and professional drivers as opposed to tax drivers.

To put this issue to bed once and for all, reform is needed around the use of a limited liability company by freelancers and contractors, who deserve to sleep easy at night. Such reform needs to recognise the need for some individuals to continue to run as standard liability companies and to also take into account both tax and employment case law. The next government, of whatever hue, should respond with a new entity to support freelancers that provides surety to clients, but also provides certainty and fairness on tax to the growing number of our freelance men and women.

Nov 12, 2014