HMRC adds to credit crunch with IR35 win in Essex

Monday, April 6th, 2009 - Employer, Employment, HMRC, Legal


HMRC IR35

St. Pauls

HMRC have been continuing their fight on IR35, and have won a case against an Essex based construction company, resulting in a bill for £800,000

Background:

UK employee’s pay two types of tax in their pay: Income Tax, and National Insurance. The later is supposed to pay/contribute for areas such as the NHS and contributions to your UK benefits including unemployment, sickness and state pension. Employers also pay a NI top-up fee on employees, equivalent to the same amount paid by the employee.

Contractors:

In the past, it was quite tax efficient for contractors and the self employed to set up their own limited company through which they operated. They then paid normal income tax rates on any direct pay, and a reduced capped rate on any dividend payment. Further, dividend payments are not normally subject to National Insurance contributions. Hence someone who as an employed contractor who may be subject to the highest rate of tax, could reduce their tax bill considerably as a contractor.

Gordon Brown’s loophole closure:

Much as though this system of operation was allowed under the Thatcher and Major “enterprise driven” governments of the Conservatives, when Labour came to power in 1997 such perceived underpayment of tax was frowned upon, and the then Chancellor Gordon Brown worked to close these tax loop holes.

On the other side of the equation, some had taken advantage of the “operating through a company” model, and had on the advice of their accountants tried to manage their tax down even further.  One of these tactics was to employ your spouse through your company, hence increasing your total non-taxed income by use of their individual income tax allowance. Effectively, a working self-employed contractor and wife both drawing down from a company could reduce their individual tax so well, they could be paying less tax than an employee earning 40% more.

IR35 and Arctic Systems:

The Gordon Brown driven Chancellery asked HMRC to bring a test case on spouses employed by companies who seemed to add little value to the operation, and could possibly be construed under s660A of tax avoidance. The company they choose was Arctic Systems, run by husband and wife team Geoff and Diana Jones. Although they eventually won the final appeal in the House of Lords in 2007, the Gordon Brown Chancellery brought in new legislation to legally close the loophole.

The second piece of legislation was IR35. The introduction of IR35 in 1999 was brought about by contractors working long-term on supposed contracts, but as they were continually employed by a company they were effectively default employees. The only difference in many cases between permanent and contract employees came down to the fact that as they were operating via a limited company, the only thing not being paid was the employers National Insurance contribution. IR35 brought in a set of tests to determine if an employee was a contractor or virtual-employee, and on the later viewed their taxation as if they were an actual employee of the company – hence making NI payments from the employer due.

The most active group of contractors against IR35 are the Professional Contractors Group, formed originally by a group of IT contractors. They have fought a continual battle against HMRC to clarify the application of IR35. As more employers had used self-employment as a way of reducing taxation, there appeared a series of organisations who guarantee their employee contracts were IR35 proof. These include Hudson’s, who contracts are backed-up by case law and the firm offers a 100% guarantee against any tax or employment law challenges.

The Essex case:

An Essex construction firm has a 100-strong workforce which it engaged using self-employment contracts drawn-up by its accountants. When HMRC investigated them, the Essex builder was so confident its self-employment contracts were water tight that it took along a group of workers to meet with revenue inspectors during a status check last summer. But seven months after the meeting, the firm was hit with a bill for £800,000.

The company is now using contracts provided by Hudson’s,  who’s construction expert David Jackson commented: “Most of the contracts are about as useful as a cardboard crash helmet. This is just the tip of the iceberg. All over the country, construction firms are harbouring an ill-founded belief that their self-employment contracts are bomb proof.”

What next?

I think David Jackson of Hudson’s is right. Not that I am an expert on construction commercial operation – it is not an area in which we operate – but in the clear need for the next UK Government to raise income to pay for the huge debts they are currently accumulating to get through the credit crunch and resultant recession. Add in the less effective way in which money is being used in Whiethall – dare we mention MP’s expenses? – the need gets even greater.

Countering this, there is also a fairness debate. Yes, enterprise should be encouraged, but the rewards at present are excessive at all levels of income just through processing a few pieces of paper and setting up a “company.” It’s not tax avoidance, but it is presently to wide a gap to justify that all are making a fair contribution to society.

Good Luck!

In thanks: I would like to thank Sarah Arrow of Essex Courier company Arrow Light Haulage for bringing this story to my attention. If you would like to join Sarah at a business networking event in Essex for Essex based businesses, then join her at an Essex Connections event

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