ir35.jpg (1742 bytes)    IR35 Consultation Group

 

PRESS RELEASE PR/990511/3 sixty

 

IR 35 – Tax Treatment of Personal Service Companies

 

What do you do when someone asks you about IR35? "I put the phone down fast and pretend it was a fault on the system!" - Maybe that quote is not the typical reaction from the majority of professionals in our Industry, but it does show one of the extremes, and the feelings are not alien to many.

As part of the recent Budget the Government announced that it was to introduce measures to counter the avoidance of Tax and National Insurance payments through the use of Personal Service Companies. They disclosed the information on a press release called IR35. The proposals are still at draft stage, with parliamentary approval being sought in Autumn 1999 for implementation in April 2000. There will be no formal consultation process, although the Revenue will listen to representations.

Through discussions with various Government Departments, including the Inland Revenue, there developed a bigger picture. Although the Revenue stated it is not their intention to abolish the Limited Company, the direction the Legislation appears to be taking would eliminate the benefits of such a trading vehicle commonly used by contract staff mainly in the IT Industry.

This way of working is not exclusive to the IT Sector, with other professions following the trend of a flexible, specialist, project based work force.

In order to publicise this issue and to generate some effective response, 3 sixty group organised an open forum session for the IT industry on 14th April 1999. Those present included John Redwood MP and Dr Vincent Cable MP, along with the CSSA, FEI, FRES, IAP, BCCS (ICC), agencies and end users. All agreed with the proposal by 3 sixty group that there should be an industry wide consultation followed by an effective lobbying campaign based on a reasoned and well presented argument. There was a consensus that the industry would lose if it went into battle with the Government.

There is a fairly broad industry understanding of the ways in which Company Directors structure their income to pay less Tax and National Insurance through the use of Dividend payments in preference to salary. Some have chosen to abuse the current system and have paid no salary and therefore no National Insurance whatsoever. In addition, some have "forgotten" to pay any Tax at all then left the UK, returning home to foreign countries.

In order to prevent these abuses, the Revenue has proposed a system where each engagement is tested to see if it is akin to employment. If the answer is yes, then it will be treated as such, with NI paid on the total salary. There would be no opportunity to claim expenses and the whole reason for using the Limited Company would disappear.

The IR35 press release goes on to explain about contractors’ loss of benefits when they move away from full-time PAYE positions, but it fails to reflect accurately the current set-up for the majority of contractors. Most Contractors replace their benefits privately using a small portion of their additional income. Contractors make educated career decisions to go contracting, with a full understanding of the needs to replace their benefits.

The Revenue has indicated that they expect to collect an additional £475m in 2000/1 and £375m in 2001/2. There are suggestions that 80% of this income would be from additional National Insurance payments.

There are few people who would disagree with the introduction of a fairer system, based on a reasonable level of NI contribution. Unfortunately, the proposals, as they currently stand, fail to recognise the full impact on the UK IT Industry and in fact UK plc.

Recent correspondence from the Revenue indicated that where the new rules apply, and the engagement is treated as employment, "The client will account for PAYE/NIC on relevant payments made to the intermediary or to the worker – broadly following existing PAYE/NICs rules." To clarify, this means that the company (who needs the work doing) will have to deduct NICs/PAYE before they pay the agency (supplying the person providing the service). This would only change if "the intermediary will itself account fully for PAYE and NICs."

When Government passes legislation it has a responsibility to look at all the effects of the proposals. In order to keep an accurate perspective on proposed legislation, there is a Department in the Cabinet Office called the Regulatory Impact Unit who are tasked with making sure people think about the these issues properly – before making changes!

The Cabinet Office advises the following on their web site:

Tests Of Good Regulation, And Pitfalls To Be Avoided:
Must have broad public support
Must be enforceable:
Must be easy to understand:
Must be balanced and avoid impetuous knee-jerk reaction:
Must avoid unintended consequences:

Excessive red tape can unnecessarily reduce the effectiveness of small
businesses

Regulations which restrict international competitiveness for example, higher
product testing requirements in the UK than elsewhere in Europe.

Must balance risk, cost and practical benefit:
Must reconcile contradictory policy objectives:
Must have accountability:
Must be relevant:

 

In order that these tests can be applied "good regulation and their enforcement should be measured against five principles:"
Transparency - Including the need for "simple and clear" regulations with guidance
in plain English
Accountability - Proposals are published and all those affected consulted before
decisions are taken
- There is a well publicised, accessible, fair and efficient appeals
procedure
Targetting
Consistency
Proportionality - Alternatives to regulation are fully considered
- The impact on all those affected by the regulation is identified,
establishing the right balance between risk and cost; no needless
demands on those being regulated – think small first

 

How do the current proposals stand up to these Government Tests:

  1. They are far from clear, with many areas of confusion and contradiction.
  2. There has not been full consultation and the Revenue has already stated that there will not be a formal consultation process.
  3. There has been little indication of acceptability of possible alternatives
  4. There has been no impact assessment carried out. In fact there seems to be little appreciation of the full extent of the affected parties and the potential risk to both companies and UK plc as a whole.

 

When we begin to look at the alternatives, we see that the UK is not the first country to go through these changes and several alternatives exist. We could adopt a minimum salary level based on a percentage of total contract value. We could adopt the approach introduced in Ireland where expenses are allowed as now (No tax and NI) and all remaining monies are paid as a salary but with employees NI only. There have been suggestions that the salary level could be based on a multiple of the minimum wage. All of these options need research and accurate impact assessment, but it quickly becomes clear that they would have less negative impact on UK Industry than the current Revenue proposals.

It has been estimated that the current bill for policing the PAYE scheme in government is £1.3Bn. Estimates of how much this would increase are varied, but there is widespread agreement that the increase could easily eliminate any additional income derived from the changes.

Why does the industry use contractors?

  1. Flexibility
  2. The need for specialist skills
  3. Speed
  4. Reduction in need for internal training
  5. Introduction of new ideas/methods

These are based on feedback from end users (but we need more)

 

What would be the effects if the legislation were passed as proposed?

  1. Potential for increased cost to end users if they have to pay NICs and contractors maintain their current earnings requirements
  2. Reduced flexibility
  3. Risk of penalty for non-compliance
  4. Potential loss of resource with contractors lured into Europe where they get a better tax treatment (35% exemption) – A Brain Drain?
  5. Loss of competitiveness for UK companies
  6. Loss of competitiveness for UK plc as a whole

So how does this fit in with the vision of our current Prime Minister and his Government?

In the White Paper "Our Competitive Future: Building the Knowledge-Driven Economy", published in December 1998 the Government set out the ambitious goal of "developing the UK as the world’s best environment for electronic trading by 2002". They went on in Net Benefit: the electronic commerce agenda for the UK to highlight the fact that electronic commerce is "crucial to the future prosperity of our economy and to the competitive position of our industries. The UK is well placed to play a leading role."

Tony Blair PM himself quoted in his Foreword to "Our information age: The Government’s Vision":

"I want to ensure that everyone in the United Kingdom has the best chance to seize this moment – our information age which offers new opportunities for greater prosperity, and better quality of life.

In this policy statement, we set out our ideas on how the Government will act to enable people to take advantage of the new information age – a co-ordinated strategy which will focus on transforming education, widening access, promoting competition and competitiveness, fostering quality and modernising government."

If we are to see a wholesale change to the current structure of the industry, what then of the Government’s own commitments to have 25% of all contacts with government to be possible electronically by 2002 and 100% by 2008? What of the commitment to a lifetime NHS record being accessible in every Doctors Surgery with NHS Direct and NHSnet offering both advice and bookings of appointments? What of the National Grid for Learning linking all schools to the Internet by 2002 and the University of Industry? The majority of central government contracts are outsourced, relying heavily on contract IT staff. What will be the effect to the public purse if costs increase?

These skills required, and the confidence in the UK IT Industry to meet these commitments was derived from the effectiveness of the current system, and it is one with which the current Government should feel justifiably proud. It is widely reported that the UK is suffering from a major skills shortage with over 100,000 IT positions left unfilled. Will the proposed changes in IR35 improve the situation?

Are we to see the current Government once again introduce a measure which will reduce the effectiveness of our IT industry, possibly put up costs and result in an exodus of our most skilled consultants to the rest of the world, where they are still seen as an invaluable commodity?

Working with all sectors of the industry, we need the views of those companies who employ contractors on the effects of IR35, in order that we can submit, on behalf of the IR35 Consultation Group Limited (non profit making company) a detailed Regulatory Impact Assessment. Please contact Brian Keegan, Iain Sutherland or Sebastian Moore on 0845 20 20 360 for further details.

 

Please register on the 3 sixty group website at www.360-group.com to receive updates on IR35 and to see the minutes of the Open Forum Meeting.

This document is copyright to 3 sixty group – it may be reproduced freely if complete and referenced to 3 sixty group