Taxman is not blameless for non-compliant umbrellas
Both attempted to achieve the desired effect in that travel expenses that would not otherwise have been allowable for tax purposes became allowable. In the case of composite companies, however, there were further tax implications in regard to avoidance of IR35 and the use of dividends to avoid employers national insurance. When comparing one with the other the tax lost in relation to composite companies was much higher and the introduction of the MSC legislation dealt with the travel expense effect of composite companies along with the other tax/NIC advantages. It was made quite clear at the time that the MSC legislation did not include umbrella companies. Yet I knew from my time at HMRC that there was serious concern over the travel expense effect of umbrellas.
Let's look at an example. If during a period of 12 months a person works for four separate employers, one workplace per employer, then the travel expense is not allowable. Each workplace is a permanent workplace because attendance at the workplace comprises the whole of the period of employment. If a person does similar work via an agency then the view of HMRC is that each engagement with the agency is separate and distinct, each one being effectively a "discrete" employment. The reason behind this is that there is no mutuality of obligation between the agency and the worker. The agency is not obliged to offer work to the worker and the worker is not obliged to accept any offer that is made by the agency. For travel to temporary workplaces to be allowable for tax purposes it is necessary for the employee to move between workplaces within the employment, or to be likely to move workplaces or that it is reasonable to assume that the employee will move workplaces. There is no continuity of employment when working for an agency and this is where the umbrella comes into its own.
By using an overarching contract continuity of employment exists and, hey presto, the travel expenses that were not allowable become allowable. So, if we go back to my original example of the person who works with four separate employers at four separate workplaces, during a 12-month period, that person cannot claim travel expenses. If, through an agency, the same person works for the same four end users that person cannot claim travel expenses. However, if that person works under an overarching contract via an umbrella for the same four end users at four different workplaces, the travel expenses are allowable.
All I have done here is to take the basic example then introduce an agency and then introduce an umbrella with an overarching contract, thereby moving further away from the reality. But in doing so, I have managed to convert non-allowable travel expenses into allowable travel expenses. Provided the overarching contract meets the tests applied by HMRC (and there are a number of contracts that do) then the expense does become genuinely allowable for tax purposes. It was not the intention of the legislation that expenses under these circumstances should be allowable for tax purposes so HMRC were faced with the question what to do about it.
Following the consultation document last year it was decided to live with umbrellas but to apply HMRC's existing powers to ensure that the overarching contracts do meet the legal tests, that dispensations/scale charges are applied correctly and that the robust audit trail is present.
Part of the problem is actually of HMRC's own making. HMRC are under pressure to grant dispensations simply because of the amount of time that is saved all round. I'm not saying that dispensations are granted 'on the nod,' but there was a time a few years ago when the staff dealing with dispensations would be unaware of exactly the nature of an umbrella company. In fact, the term 'overarching contract' had probably not been thought of and consequently any umbrella company at that time would have been granted a dispensation with the minimum of effort. It follows, therefore, that there are perhaps umbrella companies out there who do not have overarching contracts and/or whose dispensations are of doubtful validity.
Robust audit trails are essential so even if the overarching contract is in place and a valid dispensation has been granted there may still be deficiencies in the day-to-day bookkeeping. This is a weakness that will be spotted by HMRC and exploited. Also have no doubt that HMRC will scratch beneath the surface to see whether overarching contracts are applied correctly in practice. Let's look at an example.
A person is engaged in seasonal work making Christmas crackers every October, November and December and they have worked for only those three months of the year every year for the last 10 years. In these circumstances, it could prove difficult to persuade HMRC that when the employee joined the umbrella to work for the-said end user that the employee was looking forward to working beyond the current assignment. History would suggest otherwise.
HMRC is of the opinion, and many will agree with them, that the minimum wage of £5.73 is exactly that – a minimum wage. However, there are some employers who will reimburse expenses and include that within a minimum payment of £5.73. For example, they will pay £1 expenses and £4.73 wage applying tax and employers/employees NIC to the net figure. In 50/09 HMRC refer to breaches of the national minimum wage legislation and it is to this scenario that they refer.
The problem facing umbrellas that do fall foul of HMRC is the potentially enormous financial implication. Say an umbrella has not been operating its dispensation correctly as a result of which there has then the tax loss of £100 per employee per year. If there are 500 employees and five years that is a quarter of a million pounds - add interest and a hefty penalty – and, well you can work it out yourselves.
One problem facing HMRC is that they do not know exactly the number of umbrellas that are currently operating. They can use the internet in a variety of ways but, of course, it would be handy if they could identify particularly those umbrellas where there is likely to be a yield - hence HMRC's invite for end users and/or workers to get in touch.
An edited comment by Bob, the retired tax inspector.