OTS tables sole trader-style PSC reforms
The first and most “divisive” (including out of 11 other minor recommendations) is for a ‘look-through’ system of tax, “seen by some as a way of dealing with the issue of IR35.”
The reviewers, the OTS, also stated: "[IR35] could become redundant to a degree, though on the design suggested…[the look-through] would not involve employers’ NICs and so would not replicate employment."
The referred to design of the ‘look-through’ would dictate that a Personal Service Company’s shareholders pay income tax on the PSC’s profits directly, instead of paying corporation tax.
The OTS claimed: “There is a significant benefit to some company owners of a simpler look-through taxation system that ultimately puts them in the simpler sole trader tax system.”
‘Incorporated or not’
Crucially with the look-through, all small traders “incorporated or not” would pay the same rate of tax, so the incentives to formalise could no longer be liability-led, as HMRC suspects.
The main drawback to the look-through is that it would subject profits retained by the company to full income tax/NICs, and so reduce the funds available for investment and growth.
“[But] the concept of ignoring the company and simply taxing the owners – who would be taxed anyway – sounds attractive,” believes OTS’s John Whiting. “Could it work here? Would it really simplify things in practice?”
His first question relates to similar systems being in place abroad; his second relates to concern that, if introduced on the voluntary basis envisaged, OTS may be adding complexity through choice.
This would be problematical. As its name suggests (the Office of Tax Simplification), the OTS's brief was to look at ways of easing the “disproportionate” tax burden that it says exists on small companies.
Its second recommendation with the potential to change contracting meets this brief - it is for a Sole Enterprise Protected Assets (SEPA) vehicle, which would give a one-person business liability protection.
The OTS reflected: “There is merit in a system that provides protection for personal assets for sole traders, limiting their personal liability while allowing them to continue to trade as a sole trader with the associated accounting and tax treatment.”
SEPA’s potential downsides are that the structure would not give the credibility and formalised structure that incorporating does. In practice, this means it might not be engaged.
“Incorporation…provides the separate legal entity that is essential for many personal services companies to win contracts,” said the OTS. “The vast majority of potential customers in this sector will only award contracts to companies”.
In light of this shortcoming, SEPA should be worked on further by the reviewers, who will focus on its “practicability” including how the vehicle would safeguard personal assets.
‘Key’ to contracting’s future
Likewise, the other sole trader-style system with the potential to overhaul contracting - the look-through - should also be subject to further scrutiny by OTS.
And there’s a third recommendation inspired by unincorporated trading, as the review says there should be a ‘cash basis’ accounting scheme for PSCs, as there is for sole traders today.
Status expert Kate Cottrell, who was previously seconded to the OTS, last night confirmed to ContractorUK that two of the review's major recommendations may be “key” to the future of contracting.
She said: “[What] could affect contractors is the SEPA [and the] look-through…[but] I cannot imagine that the introduction of the SEPA would, or could, result in the payment of less tax and NICs”.
So while it is unlikely that contractors’ tax liabilities will reduce, there could be the option of a new trading vehicle yet it would "not [be] the same as the Freelancer Limited Company," Cottrell pointed out.
Indeed, the review does frame the FLC as being separate from SEPA, partly because the FLC model has been revised since the OTS found “significant issues” with it in its employment status review.
Due to these revisions, the FLC is now “worth considering” again, said the office while cautioning: “we are conscious of the risks involved with seeking to give a route out of the ambit of IR35.”
But it's the Intermediaries legislation which Cottrell believes the review raises some interesting questions about, even though OTS did not directly consider it. She cited two paragraphs, emphasising the latter parts in particular.
The first on (page 7 of the review) stating that, “We have not explicitly considered the existing intermediaries’ legislation (IR35) as the government has issued a discussion document which is running in parallel to this review.”
And the second (on page 86) stating that, “Accordingly, the OTS review will not specifically consider IR35 but will liaise closely with that work stream.”
Cottrell reflected: “The OTS stating that this report was running in parallel with the IR35 discussion document…suggests a number of possibilities. These could be that an IR35 consultation could be forthcoming and this could also run in parallel with further work on the SEPA. We will have to wait until March 16th for Budget 2016.”