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View Full Version : Charlie and Thomas -- Another Nice Example from HMRC



WordIsBond
21st May 2018, 18:37
The HMRC Consultation on IR35 (https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/708544/Off-payroll_working_in_the_private_sector_-_consultation_document.pdf) includes another example of HMRC's one-sided "analysis." On page nine, Charlie and Thomas are compared. I'll assume you all can read it, I won't give the details.

After the infamous Ben/Jo case study of 2015 (https://forums.contractoruk.com/future-contracting/108574-ben-jo-case-study-ir35.html), I don't trust them anymore, so I decided to run some numbers myself. The mistakes here aren't quite as egregious as that one. There's really only one substantive error, and that is that they forgot the pension contributions which ABC Ltd is mandated to make on behalf of Thomas. So I've assumed that the £50K cost of employing Thomas includes not only salary and NI but pension contributions as well. I've used the 3% that they will be required to pay by 2019, and assumed Thomas makes the 4% Pension AE mandated contribution.

I won't bore you with every number, but I end up with Thomas having a gross salary of £44168.82, Employer's NI of 4506.11, and employer pension contribution of 1325.07, total cost £50K. Thomas will be making his own pension contribution under AE of £1766.75 (total combined pension contribution £3091.82). The final net result is that HMRC takes £14693.87, and Thomas has a pension contribution of £3091.82 and take home pay of £32,214.31.

In Charlie's case, outside of IR35, he has expenses of £2500, the same pension contribution as Thomas (£3091.82), and ends up paying £8616.09 (Corporation tax and dividend tax). As with HMRC's calc, it's about £6K less than ABC/Thomas. Charlie's take-home pay is £35792.10 -- about £3500 more than Thomas, right? But £3500 isn't a particularly high premium when you aren't receiving any employment rights. From HMRC's perspective, it isn't fair that Charlie pays THEM less. But from Charlie's perspective, he's not getting very much compensation for the loss of employment rights, is he?

But HMRC's solution to the unfairness is to force Charlie inside IR35, with the result that he will pay an extra £5K, approximately. Now, that's nice and fair for THEM because they get close to the same amount of money. But it is hardly fair for Charlie. Now, he has LESS take-home pay than Thomas, no guarantee of work after this contract, in fact no guarantee he won't be dumped without notice, no holiday pay, no employment rights at all, and HMRC in their wisdom have decided his take-home pay should be less than the employee's.

Their very own example proves that what they want to do, force more people into IR35, will not be "more fair", it will drive people out of contracting and destroy the flexible work-force. From their perspective, they think that narrows the tax gap. But from Charlie's perspective, it means contracting is a loser. There's no reason to do it, to take the risks and forgo the employment rights, if he's going to be in a worse position financially for having done so.

Their own example proves that the reform that is needed is not to find a way to force more people into IR35, it is to reform IR35 itself so that it is less punitive. As long as IR35 is punitive, people are going to take chances with "creative" ways to avoid it. If your goal is increased compliance, you have to A) make it more reasonable from the perspective of those who are supposed to be complying and B) actually make it clear enough that people aren't easily confused as to whether or not they should be inside or not. Since HMRC, in case after case that they've lost in the courts, has demonstrated that even they don't understand the legal position, B has a long way to go.

But even if you make it clear, if IR35 makes a contractor worse off than an employee doing the same job in the same way, and the employee also has employment rights, you will not get increased compliance. There will be schemes and plans and creative avoidance and just blatantly ignoring it. You have to stop making it punitive. It's simple human nature -- the more outrageous your treatment of someone, the less likely they are to continue to submit to that treatment. Charlie won't do it. No matter how much they want him to, he's not going to operate that contract within IR35. He'll either quit contracting, and you no longer have a flexible workforce, or he'll find a way to dodge IR35. You have to have a more substantive reform of IR35. You can talk about "fair" all you want and try to force Charlie inside IR35 but in the real world that simply isn't going to happen.

This consultation is useless because it is focused on how you can force more people into IR35 instead of how you can make IR35 more fair and less punitive. If you do that, you'll get better compliance. If you don't, you proliferate avoidance and evasion, and you have to hire hundreds or thousands more tax inspectors. If HMRC are right that 90% of those who should be inside aren't, they should be asking themselves why 90% are willing to take such a risk. That's the real question they haven't answered and don't have the integrity to ask.

Yorkie62
22nd May 2018, 08:15
Not sure if you included this but don't forget the Employer NI contributions, and Apprenticeship levee that by being placed inside IR35 Charlie will be forced to pay by the agency that is be enforcing HMRCs inside IR35 payroll.

Nothing like a fair taxation system, which is HMRCs stated aim of all this.

GreenMirror
22nd May 2018, 08:30
HMRC and government should aim for a simpler taxation system.

WordIsBond
22nd May 2018, 08:55
Not sure if you included this but don't forget the Employer NI contributions, and Apprenticeship levee that by being placed inside IR35 Charlie will be forced to pay by the agency that is be enforcing HMRCs inside IR35 payroll.

Nothing like a fair taxation system, which is HMRCs stated aim of all this.
The HMRC example had neither agency nor umbrella fees. If you added that, the expenses coming out of Charlie's £50K would be much higher than 5%, obviously.

I included the Employer NI but not the Apprenticeship levee. We're not told in the example how big ABC Ltd is and whether they have to pay the Apprenticeship levee or not, so I didn't include it.

WordIsBond
22nd May 2018, 09:52
The comparison between Charlie and Thomas is flawed because of employment rights, and the compensation that comes with them. HMRC has ruled any discussion of employment rights out of scope, but that doesn't mean they don't exist.

In fact, Charlie is not going to do the same job as Thomas for a £50K contract. Everyone knows this. He's more likely to be working for £50 / hour. He'll take holidays, just like Thomas, but unpaid, and sick days, and paternity leave. He'll also have bench time between contracts, a risk he's decided to take. ABC Ltd is going to pay PSC Ltd more than £50K to compensate for all these risks and for the lack of employment rights. Charlie's company is NOT going to receive £50K. They are more likely to receive £70K -- that's the only way to make a useful comparison.

That's the real world. In simplistic HMRC examples, payments are the same for the same work. In the real world, payments are not the same because there are not the same rights even if the two are doing the same work.

If we run the numbers that way, what do we get?

PSC Ltd still has 5% expenses, now £3500. We'll assume Charlie still gets the same pension as Thomas, £3091, contributed by PSC Ltd. Now, PSC Ltd pays £10,636 in Corporation Tax. Charlie pays dividend tax of £4586. The total combined tax payment from PSC/Charlie is £15033.13, compared to the combined tax payment of ABC/Thomas of £14,693.87. In the real world, Charlie Contractor pays more tax for doing the same work than Thomas does.

Charlie also has a higher take home pay to compensate him for the risks he is taking. Next year, his wife will have a baby, he'll be off work unpaid for a week. Next summer, the contract will end, and he'll be on the bench for three months before he gets another one. Two years from now, he'll be in a car accident and off work for two months. His contract will be terminated because they need the project completed and he can't deliver. Fortunately, he'll get another contract quickly once he's recovered. But in all that down time, he'll be depending on the extra income he's received.

Thomas will get paternity pay, not be on the bench, and won't lose his job if he's in a car accident. His take home pay is lower because he's not taking that risk.

But Charlie has paid more tax than Thomas even if he is outside IR35. If he is inside IR35, he'll pay almost £7K more tax than Thomas, even though they are doing the same work.

Is it fair that when two people are doing the same work, one pays £7K more tax than the other? That's what IR35 does in real life.

HMRC's comparisons only work if employment rights have no value at all. That's why they will not arrive at a fair solution -- they are acting as if employment rights have no economic value at all.

In their example, Thomas/ABC should pay more tax because Thomas' compensation is truly much higher than Charlie's. You have to put an economic value on employment rights to do this comparison.

Old Greg
23rd May 2018, 06:34
The comparison between Charlie and Thomas is flawed because of employment rights, and the compensation that comes with them. HMRC has ruled any discussion of employment rights out of scope, but that doesn't mean they don't exist.

In fact, Charlie is not going to do the same job as Thomas for a £50K contract. Everyone knows this. He's more likely to be working for £50 / hour. He'll take holidays, just like Thomas, but unpaid, and sick days, and paternity leave. He'll also have bench time between contracts, a risk he's decided to take. ABC Ltd is going to pay PSC Ltd more than £50K to compensate for all these risks and for the lack of employment rights. Charlie's company is NOT going to receive £50K. They are more likely to receive £70K -- that's the only way to make a useful comparison.

That's the real world. In simplistic HMRC examples, payments are the same for the same work. In the real world, payments are not the same because there are not the same rights even if the two are doing the same work.

If we run the numbers that way, what do we get?

PSC Ltd still has 5% expenses, now £3500. We'll assume Charlie still gets the same pension as Thomas, £3091, contributed by PSC Ltd. Now, PSC Ltd pays £10,636 in Corporation Tax. Charlie pays dividend tax of £4586. The total combined tax payment from PSC/Charlie is £15033.13, compared to the combined tax payment of ABC/Thomas of £14,693.87. In the real world, Charlie Contractor pays more tax for doing the same work than Thomas does.

Charlie also has a higher take home pay to compensate him for the risks he is taking. Next year, his wife will have a baby, he'll be off work unpaid for a week. Next summer, the contract will end, and he'll be on the bench for three months before he gets another one. Two years from now, he'll be in a car accident and off work for two months. His contract will be terminated because they need the project completed and he can't deliver. Fortunately, he'll get another contract quickly once he's recovered. But in all that down time, he'll be depending on the extra income he's received.

Thomas will get paternity pay, not be on the bench, and won't lose his job if he's in a car accident. His take home pay is lower because he's not taking that risk.

But Charlie has paid more tax than Thomas even if he is outside IR35. If he is inside IR35, he'll pay almost £7K more tax than Thomas, even though they are doing the same work.

Is it fair that when two people are doing the same work, one pays £7K more tax than the other? That's what IR35 does in real life.

HMRC's comparisons only work if employment rights have no value at all. That's why they will not arrive at a fair solution -- they are acting as if employment rights have no economic value at all.

In their example, Thomas/ABC should pay more tax because Thomas' compensation is truly much higher than Charlie's. You have to put an economic value on employment rights to do this comparison.

As I've said elsewhere, the Irish tax treatment of contractors works pretty well (except travel expenses). Divis are treated as earned income so there is no advantage to that route. Salary is then treated as if you are a sole trader with a lower rate of the NIC equivalent and no employers NIC equivalent.

WordIsBond
23rd May 2018, 08:57
As I've said elsewhere, the Irish tax treatment of contractors works pretty well (except travel expenses). Divis are treated as earned income so there is no advantage to that route. Salary is then treated as if you are a sole trader with a lower rate of the NIC equivalent and no employers NIC equivalent.
Simpler is usually better, and that is simpler.

The problem with it is double taxation for "normal" companies (as opposed to one man bands). The corporation is taxed on the profits and then the dividend is taxed again as normal income when distributed. Ireland mitigates that problem with a low corporation tax rate as well as, I believe, some pretty substantive corporation tax breaks for many companies.

The whole IR35 problem is because of significant imbalances between the taxation of employees, self-employed, and one-man band Ltd companies. If you remove some of those imbalances IR35 could just be sent to its well-deserved grave. But the solution can't turn into a disincentive for entrepreneurship, nor can it damage UK plc, nor can it make contracting so unattractive that no one wants to do it, thus killing the flexible work-force.

The real imbalance comes with Employer NI. In the Charlie/Thomas example, the taxation is virtually equal between the two cases, except for Employer NI. Charlie and Thomas are paying reasonably close to the same tax, in their example. But Thomas' employer is also paying £4500 in Employer NI.

Maslins
23rd May 2018, 10:27
But HMRC's solution to the unfairness is to force Charlie inside IR35, with the result that he will pay an extra £5K, approximately. Now, that's nice and fair for THEM because they get close to the same amount of money. But it is hardly fair for Charlie. Now, he has LESS take-home pay than Thomas, no guarantee of work after this contract, in fact no guarantee he won't be dumped without notice, no holiday pay, no employment rights at all, and HMRC in their wisdom have decided his take-home pay should be less than the employee's.

(Devil's advocate)

Surely HMRC should only be concerned about what's fair for them.

Who benefits from the lack of work guarantee, ease of dumping, lack of holiday pay, lack of employment rights? The client/employer does surely. HMRC don't benefit from it (bar perhaps some tenuous argument re higher chance of job seeker's allowance etc).

So what should really happen is end client offers person £50k employed salary or £60k contract rate (or £70k, precise figure irrelevant, key thing is it's more to compensate for lower rights). The tax is at the same rate (obviously more tax paid if income is higher). The client then pays more for not having to give the individual employment rights. The individual receives more money (through higher pay, not lower taxes) to compensate for lower rights.

Why should HMRC (UK Plc) suffer because the individual and the end client agree to treat things in a non employed way?

WordIsBond
23rd May 2018, 11:00
(Devil's advocate)

Surely HMRC should only be concerned about what's fair for them.

Who benefits from the lack of work guarantee, ease of dumping, lack of holiday pay, lack of employment rights? The client/employer does surely. HMRC don't benefit from it (bar perhaps some tenuous argument re higher chance of job seeker's allowance etc).

So what should really happen is end client offers person £50k employed salary or £60k contract rate (or £70k, precise figure irrelevant, key thing is it's more to compensate for lower rights). The tax is at the same rate (obviously more tax paid if income is higher). The client then pays more for not having to give the individual employment rights. The individual receives more money (through higher pay, not lower taxes) to compensate for lower rights.

Why should HMRC (UK Plc) suffer because the individual and the end client agree to treat things in a non employed way?
And thus demonstrating that the HMRC example is a nonsense. It won't happen. Charlie will be paid more and will pay more tax than in their example. Thus my follow-up post, using £70K as Charlie's compensation, which is actually something that could happen in the real world, for a comparative contractor to a £44K salaried position.

HMRC maybe should only be concerned about what's "fair for them" but HMG should care about incentives and disincentives to entrepreneurship, and the economic benefits of a functioning flexible workforce.

You can run the numbers as well as I can, let me know if I'm wrong. In fact, you probably have software that would do it automatically where I have to use a spreadsheet. :D

If ABC Ltd offers a choice between a £44K perm salary (plus AE pension contributions, total cost £50K) or a £70K contract through PSC Ltd, it is virtually tax neutral for HMRC which choice Charlie and Thomas make. They'll actually pull in more from the guy who takes the contractor route, even if he's outside IR35. The reason is because, even though rates aren't equal, Charlie receives monetary compensation for the employment rights (that's what happens in the real world) and that compensation is subject to tax. Thomas receives the tax-free benefit of the employment rights. That inequality is mostly (but not quite entirely) balanced out by the disparity in tax rates. The result is that Charlie pays more, and UK plc is not hurt at all by Charlie's decision to go the contractor route.

When HMRC start taxing the value of employment rights then it will be "fair" for them to tax the amount that is paid in lieu of employment rights.

madame SasGuru
23rd May 2018, 12:30
When HMRC start taxing the value of employment rights then it will be "fair" for them to tax the amount that is paid in lieu of employment rights.

Isn't that called Employer's NI?

WordIsBond
23rd May 2018, 15:09
Isn't that called Employer's NI?
Hardly. Employer's NI is paid on the cash compensation paid to an employee.

Roughly speaking, the value of employment rights is calculated by taking the price a client would be willing to pay for a contractor, and subtracting from it the things they would be willing to pay for an employee of equivalent value -- wages, Employer NI, pension contributions. The difference is what it is worth to them to not have to give the contractor employment rights -- security/MOO, holiday pay, sick pay, redundancy pay, etc. That value, whatever it is, is something that the employee receives and is not taxed on it. The contractor does not receive those things but he does receive money (a higher rate) to compensate him for them, and is taxed on it.

In the example I gave above, ABC Ltd was willing to pay £50K (tax, pension, salary) for Thomas, but £70K for Charlie. There's a £20K differential there, and it is all about the value of employment rights. Maybe £20K is too high, they'd only pay £65K for Charlie, and the employment rights are only worth £15K. Doesn't matter the amount, the point is that it is worth SOMETHING and Thomas doesn't have to pay tax on it and Charlie does. If Charlie has to pay tax on the same basis and at the same rates that Thomas does, AND has to pay tax on the money he gets in lieu of employment rights, he's being unfairly taxed. Thomas gets the employment rights tax free.

If HMRC would give PSCs an "employment rights allowance" where a certain percentage is not taxed because they are compensation for employment rights, IR35 would be more equitable/less punitive and compliance would be better. If you really think you only have 10% compliance and 90% non-compliance you are admitting that you've structured the thing very badly. Either you've made it so complicated that it is too hard to comply, or you've made it so imbalanced that people have such a strong incentive to cheat that 90% of them will. There are few areas of life where 90% will cheat.

PurpleGorilla
5th June 2018, 05:17
They never mention the VAT raised for the exchequer - if I’m inside IR35 then they don’t get that!

madame SasGuru
5th June 2018, 12:35
They never mention the VAT raised for the exchequer - if I’m inside IR35 then they don’t get that!

How many times do I have to login and repeat the following:-

HMRC regards business to business VAT as revenue neutral* - they will either receive the money from your company or the company that employs you rather than your company.

* Yes I know banks, insurance and local authorities are slightly different but not enough to make a difference here.

swamp
6th June 2018, 12:26
How many times do I have to login and repeat the following:-

HMRC regards business to business VAT as revenue neutral* - they will either receive the money from your company or the company that employs you rather than your company.

* Yes I know banks, insurance and local authorities are slightly different but not enough to make a difference here.

Rubbish: HMRC collect £120bn a year from VAT. That is hardly "revenue neutral"!

For every £500 per day contractor at a bank the government trousers an extra £100. That's tax that a permanent employee (at the same bank) is not expected to pay.

madame SasGuru
6th June 2018, 14:15
Rubbish: HMRC collect £120bn a year from VAT. That is hardly "revenue neutral"!

For every £500 per day contractor at a bank the government trousers an extra £100. That's tax that a permanent employee (at the same bank) is not expected to pay.

and of the £120bn HMRC receives exactly how much of that is contractors in banks? If it's 1% I would be shocked...

And remember I'm merely repeating HMRC's view here not my own..

fidot
6th June 2018, 14:29
Rubbish: HMRC collect £120bn a year from VAT. That is hardly "revenue neutral"!

For every £500 per day contractor at a bank the government trousers an extra £100. That's tax that a permanent employee (at the same bank) is not expected to pay.

The £120bn mostly comes from the end consumer.

In the general case (i.e. excluding banks, insurance and local authorities), VAT is just passed along the chain. One company's input VAT is another's output VAT, which is why it is regarded as revenue neutral.

WordIsBond
6th June 2018, 14:57
Rubbish: HMRC collect £120bn a year from VAT. That is hardly "revenue neutral"!

For every £500 per day contractor at a bank the government trousers an extra £100. That's tax that a permanent employee (at the same bank) is not expected to pay.
It is grievously painful for me to ever agree with madame, but in this case, he/she/it is correct.

In almost every case of a £500 per day contractor, the client pays the contractor £100, the contractor pays HMRC £100, and the client reclaims the £100 from HMRC. The only thing that is accomplished by this circus is it marginally stimulates the economy by providing employment for bods to keep track of and report the whole thing, a benefit which is more than washed out by the cost of the HMRC bods who keep track and enforce it on their end.

Well, one other thing is accomplished. It allows HMG to pretend that companies are paying the tax when anyone with 1/4 of a brain knows it is the consumer.

And yes, there are exceptions, but not enough to matter.

VAT does not belong in these discussion. It just confuses matters.

swamp
6th June 2018, 18:09
It is grievously painful for me to ever agree with madame, but in this case, he/she/it is correct.

In almost every case of a £500 per day contractor, the client pays the contractor £100, the contractor pays HMRC £100, and the client reclaims the £100 from HMRC. The only thing that is accomplished by this circus is it marginally stimulates the economy by providing employment for bods to keep track of and report the whole thing, a benefit which is more than washed out by the cost of the HMRC bods who keep track and enforce it on their end.

Well, one other thing is accomplished. It allows HMG to pretend that companies are paying the tax when anyone with 1/4 of a brain knows it is the consumer.

And yes, there are exceptions, but not enough to matter.

VAT does not belong in these discussion. It just confuses matters.

Banks, insurance companies, charities, law firms, and most of the public sector cannot reclaim VAT because they cannot register for VAT.

Sure if you contract at a telco, say BT, then the VAT is neutral because BT are permitted to register for VAT. But you contract at Goldman Sachs, say, then the treasury gets £100 a day extra.

Acme Thunderer
6th June 2018, 19:58
Banks, insurance companies, charities, law firms, and most of the public sector cannot reclaim VAT because they cannot register for VAT.

Sure if you contract at a telco, say BT, then the VAT is neutral because BT are permitted to register for VAT. But you contract at Goldman Sachs, say, then the treasury gets £100 a day extra.

Even if the end client can't reclaim VAT if you go through an agency they can (and will) reclaim the VAT, so it remains Tax neutral e.g.

VAT registered contractor gets £500pd and add VAT £100, Agency charges end client £600pd, VAT of £120 but claims back £100 (from contractors invoice) - Tax man gets £120 VAT in total (£100 contractor and £20 agency)

Non VAT registered contractor gets £500pd, Agency charges end client £600pd, VAT of £120 - Tax man gets £120 VAT

So it only makes a difference if the end client isn't VAT registered AND you are going direct

swamp
6th June 2018, 20:51
Even if the end client can't reclaim VAT if you go through an agency they can (and will) reclaim the VAT, so it remains Tax neutral e.g.

VAT registered contractor gets £500pd and add VAT £100, Agency charges end client £600pd, VAT of £120 but claims back £100 (from contractors invoice) - Tax man gets £120 VAT in total (£100 contractor and £20 agency)

Non VAT registered contractor gets £500pd, Agency charges end client £600pd, VAT of £120 - Tax man gets £120 VAT

So it only makes a difference if the end client isn't VAT registered AND you are going direct

Tax man now gets £120 a day with the agency and its margin. This is not "tax neutral"; this is an even more egregious example!

Acme Thunderer
6th June 2018, 20:55
Tax man now gets £120 a day with the agency and its margin. This is not "tax neutral"; this is an even more egregious example!

In both examples the VAT man gets £120. First one £100 from contractor and £20 from agency. 2nd one £120 from agency. So makes no difference if contractor is VAT registered or not.

Brussels Slumdog
20th June 2018, 15:42
Slumdog will do Charlie's work remotely 3 out of 5 days a week as a Belgian self employed.