How the curb on contractor expenses might play out
Seeing as the Finance Bill 2016 gave us a much clearer picture of the restrictions to tax relief on travel and subsistence for workers engaged via an employment intermediary (a PSC or umbrella), let’s explore how they might play out in the ‘real-world,’ writes Marc Scott, a director of Liberty Bishop.
As of the new tax year (6th April 2016), new restrictions will apply to the application of tax relief on travel and subsistence expenses when the worker in question is engaged via an employment intermediary (the definition of which encompasses both an umbrella company and a PSC).
The restrictions essentially revolve around the issue of employment status and basically state that if an individual's working practices indicate that they are more like an employed-type worker, then access to tax relief on travel and subsistence will be denied. But this is where it gets a bit more complicated, because there isn't a singular test that is to be used in order to determine whether or not a worker is an employed-type worker. Instead there's actually two different tests:
* one designed for umbrella company workers that uses the yardstick of "Supervision, Direction, or Control" (SDC) to determine whether a worker can gain travel and subsistence relief.
* and a separate test (the intermediaries legislation - IR35) to determine whether a worker engaged via a PSC gets access to travel and subsistence relief.
'Overly complicated and burdensome'
This two-test approach was not HMRC's initial intention, and did not appear in the original consultation document. We learn from the "Summary of Responses" to the initial consultation document that this was a relatively late revision - following on from stakeholder feedback during the consultation process. It was introduced to acknowledge that it would be "overly complicated and burdensome" (3.21, p.10) for PSCs to have to consider two different tests for each assignment; an SDC test to determine their eligibility for travel and subsistence relief, and the IR35 test to determine whether they could avoid employment taxes by receiving dividend payments.
This two-test approach does raise some interesting questions and observations but we first need to address another late revision that did not appear in the original consultation document; the decision to implement a particular debt transfer structure that only arose out of discussions during the consultation process itself; at the roundtable events that we were involved in.
What we’ve got isn’t what was proposed
As you may recall, the original consultation proposal offered up two debt transfer options, and essentially asked stakeholders to pick which one they thought would work best. The first option proposed that the debt liability would be held jointly and severally between the employment intermediary and the engager. The second option, however, proposed that the liability would only sit with the employment intermediary, unless the employment intermediary had been misled in such a way that it caused it to generate a travel and subsistence tax debt. In this scenario the debt could be transferred.
What we are now presented with, however, is a "third option" whereby we have a two-pronged approach that will see either the debt transferred jointly and severally from the employment intermediary to its own director(s) in instances where there has been a conscious misapplication of the rules by the employment intermediary and the guidance of the engager had been ignored, or alternatively the debt transferred from the employment intermediary to another party (e.g. the engager) in instances where it can be shown that the employment intermediary has been misled by that party into believing travel and subsistence relief was allowable when in fact it was not. The argument made in favour of this more sophisticated model of debt transfer is that it's able to effectively penalise both those engagers that would mislead an employment intermediary, and also those employment intermediary directors that would otherwise deliberately disregard the rules and - should they get caught - simply liquidate their employment intermediary and avoid any personal liability.
So what can we say about this new travel and subsistence framework from a ‘real-word’ perspective? Does the tax theory work in practice, and what impact is it likely to have on UK contracting?
'Decrease in the use of umbrella companies'
We can frame our answer in the context of a possibility that HMRC itself openly acknowledges; that these changes ‘may result in a decrease in the use of umbrella companies and a corresponding increase in the use of other types of employment intermediaries.’ Now HMRC doesn't specifically reference PSCs as the other types of employment intermediary, but considering what the definition of an employment intermediary covers, and considering the other recent legislation that has been introduced to restrict the use of offshore intermediaries and engaging via sole trader status, it's hard to envisage that HMRC has in mind anything other than PSCs when it refers to this potential increase.
We would have to agree that there is likely to be a migration away from the use of umbrella companies towards limited company incorporation. These legislative changes assume that SDC applies when working through an umbrella company, so the onus is on the engager to demonstrate that this is not the case. Since it is notoriously difficult to prove a negative - a lack of supervision, direction, or control - it is likely that the umbrella model will become a less tax-efficient option for the vast majority of current umbrella company employees. While HMRC would obviously argue that this reduction in tax efficiency is justified, from the workers' perspective they are going to be out-of-pocket and it's hard to imagine that they won't be looking for ways of recovering these losses.
All of this is further compounded by the fact that last-minute revisions to the Finance Bill 2015 (now enacted into law) will shortly prevent contractors who use umbrella companies from claiming tax relief on any expenses on an ongoing basis via the umbrella PAYE process. Instead, expenses incurred during the course of umbrella company employment will need to be offset via the end-of-year self-assessment method. These changes are detailed sub-section 5b of Section 289A of the March 2015 Finance Act.
'Drastically diminished appeal’
It appears, then, that the interaction between these two aspects of tax law will essentially mean that the issue of SDC will only determine whether or not an umbrella worker can claim T&S tax relief at the end of the tax year through self-assessment, since there is no possibility of any expenses relief being given on an ongoing basis via the umbrella PAYE mechanism. Lord Palmer has recently discussed this amendment to the 2015 Finance Act in the House of Lords, pointing out that not only does delaying the receipt of tax relief in this way penalise umbrella workers, but forcing all umbrella workers to claim via the self-assessment route also increases the likelihood that they'll need to employ the services of an accountant to ensure their affairs are in order, which of course will come at additional cost on top of the fees they're already paying to the umbrella company for processing their payments. Given this set of circumstances, would it be surprising if the appeal of the umbrella model was drastically diminished come April 2016?
It's also worth mentioning that the interaction between these two aspects of tax law also appears to cause potential problems for the particular transfer of debt model that HMRC has chosen to adopt in order to police T&S claims. If the umbrella company is not able to offset any of its employees' expenses under PAYE as part of the umbrella company service, then how can the umbrella company (as the employment intermediary), its director(s), or the engagers ever be reasonably held accountable should a worker incorrectly decide to offset T&S expenses at the end of the tax year via a self assessment that neither his engagers, nor his umbrella company employer, have any awareness of, or control over?
A follow-up question we’re hearing a lot of people ask is -- what can be said about the other employment intermediary option that is expected to step in to cater for many of the at least 400,000 umbrella workers who may be looking for an alternative?
Clearly the most important point to cover with respect to PSCs is the (unintended) consequences that result from IR35 being used as the test for travel and subsistence relief instead of the SDC test that'll be used with regards to umbrella workers.
There are a couple of issues. Firstly, given that they are two distinct tests, is it possible that discrepancies will arise in access to the same tax benefit, for workers carrying out the same role, simply because they use different types of employment intermediary and therefore "sit" different tests? And secondly, could such a possibility lead to any commercial advantage for PSCs?
More Questions (continued)
It's difficult to answer this first question at such an early stage, when the changes have not yet come into force and we therefore have no practical experience of how they'll be interpreted ‘on the ground’, but it seems fair comment to say that since an engager will only get involved in the process when they're determining SDC in relation to an umbrella employee, and not when a PSC is considering IR35, the simple fact of the disparity in engager involvement itself may have an impact on outcomes. We're reminded of the old adage "two heads are better than one", and it seems reasonable to speculate that an engager and an umbrella worker (when putting their heads together over the issue of SDC on the role in question) will have a better chance of getting the right result than when a PSC director is left to his own devices to consider IR35 in relation to the role without the engagers input. Our suspicion is that in this scenario, we will see PSCs tending to find themselves outside of IR35 far more often than umbrella workers are found to be lacking SDC, even when the role in question is one and the same.
By PSCs getting the ‘wrong’ result more frequently, this means, of course, that they are actually at a tax (and therefore commercial) advantage by offsetting travel and subsistence relief incorrectly. It's true that this tax advantage is actually a tax debt to be transferred to the director personally should this relief result from a deliberate misapplication of the rules, but what if it's an honest mistake made primarily due to the lack of engager input when determining IR35 status? And even if it was a deliberate misapplication, this merely puts us in the same position that we're already in with regards to IR35 and dividend payments; that IR35 is often abused but that PSCs are willing to run this associated risks because HMRC are under-resourced and cannot catch everyone.
This brings us onto our final point that is worth making; that so much of the success of these legislative changes will be dependent upon what government chooses to do with any future revisions of IR35. As things currently stand, these changes around employment intermediaries and travel and subsistence clearly seem to favour increased volumes of limited company incorporation, but this would not necessarily be a long-term trend should revisions be made to IR35 which have the effect of stemming the flow away from umbrella companies. Only time will tell what happens in this area but, rest assured, we will be involved in the consultation process and will be keeping umbrella contractors’ best interests at heart.