The new legislation that penalises managed service companies–companies that are run for contractors by providers–has sent a powerful message throughout the industry. There is real concern on the part of agencies and recruiters about the status of the contractors they work with. Are you running your own limited company, or is someone else running it for you? In the latter case, you may have trouble getting more work.

Demand for Repayment Without Notice

Says David Vincent of the London-based Lawspeed, a legal consultancy specialising in contractor affairs: Recruiters and agencies are most likely to be concerned about 3rd Party Liability – tax debt arising from an association with a managed service company which incurs a tax debt that HM Revenue and Customs cannot recover. Recruiters could be liable for managed service company tax debts after 6 January 2008 and the sums involved could be very significant especially where a recruiter or agency has a large number of contractors on their books.”

”If a transfer of debt is activated there is an immediate joint and several liability for the agency or recruiter whether or not a debt notice is served,” Vincent explains. This means that the employment provider could find itself liable for contractor tax debt without even knowing about it! The Revenue will simply appear at the door, as it were, one day and demand repayment.

” Recruiters and agencies are likely to view this as very unfair because it could have a very detrimental effect on the balance sheet and overall value of their businesses.”

Checking on Status

“Recruiters are likely to be more prescriptive in determining whether a worker company is a managed service company, This may add to administration and slow down the sign up process,” Vincent warns.

In other words, your agency or your recruiter will want to be very certain that you are not working in anything that could be even loosely defined as a managed service company. Some agencies have already circulated questionnaires to their contractors asking for definitions of status. But this is probably only the beginning, as further checks will be made, probably extensive ones at the times a contractor is under consideration for a given contract.

Compliance Checks

What Lawspeed expects is that recruiters and agencies will undertake regular compliance checks of their contractors as well. And they will want to ensure that providers register all their limited companies with the Revenue. “They will also undertake spot checks on PAYE slips provided to the worker to ensure payment is full PAYE,” Vincent adds.

What this means in practice is that contractors should know for certain what the status is of the limited companies they are running, and that they should be in a position to prove that status if required to do so. If contractors are unable to prove the independent status of the companies they run, they risk losing contracts.

Contractors need to be very aware of this issue which is unquestionably the hottest topic in the industry today. Ignore it at your peril.

Contractor Calculator

The Intermediaries legislation was introduced on 6th April 2000. It was first proposed by the Chancellor in the 1999 Budget and details were given in the Budget press release numbered IR35. Following extensive consultation, revised proposals were announced in a new press release dated 23 September 1999. However, the legislation is now commonly referred to as ‘IR35’.

The aim of the legislation is to eliminate the avoidance of tax and National Insurance Contributions (NICs) through the use of intermediaries, such as Personal Service Companies or partnerships, in circumstances where an individual worker would otherwise -

For tax purposes, be regarded as an employee of the client; and

For NICs purposes, be regarded as employed in employed earner’s employment by the client.

Prior to the introduction of the legislation, an individual could avoid being taxed as an employee on payments for services and paying Class 1 NIC by providing those services through an intermediary. The worker could take the money out of the intermediary, normally a Personal Service Company, in the form of dividends instead of salary. As dividends are not liable to NICs, the use of a dividend remuneration strategy results in the worker paying less in NICs than either a conventional employee or a self-employed person. And PAYE would not apply to the dividends.

The legislation ensures that, if the relationship between the worker and the client would have been one of employment had it not been for an intermediary the worker pays broadly tax and NICs on a basis which is fair in relation to what an employee of the client would pay.

On 6 April 2007 Chapter 9 ITEPA 2003, more commonly known as the Managed Service Company (“MSC”) Legislation, was introduced. The MSC Legislation applies to individuals providing their services through intermediaries which meet the definition of a Managed Service Company.

An intermediary must consider whether the MSC Legislation applies before considering IR35. Intermediaries that do not meet the definition of an MSC must continue to consider IR35.

HMRC

It is clearly an attempt to extract more money out of the industry. They have estimated that of the 860,000 self employed subcontractors in the UK 300,000 have been wrongly described as self employed and if these workers were re-classified as employees the Treasury would benefit to the sum of £350 million per year.

The proposals are that to be classified as self employed the workers should meet one or more of three criteria:

1. The worker must provide plant and equipment, not just the tools of his trade.
2. The worker must provide all materials.
3. The worker must employ other workers. He will be responsible for ensuring the correct criteria are met for his workers.

The problems that these criteria create are wide ranging and as usual provide more questions than answers.

Most small contractors would like to have their own plant and machinery but do not have the finance to fund their purchase. What would HMRC’s view be if for a few days per year the subcontractor hired a machine to assist him in his work?

Materials are often purchased by the main contractor where possible because of the financial benefits of bulk purchases. So if each subcontractor purchased his own materials the costs would escalate. Again we wonder how HMRC will react to the contractor charging the subcontractor for the material used and for the subcontractor to add this on to his own invoice.

The third criteria seems to penalise small businesses but we wonder how HMRC will react to partnerships?
On a positive note the subcontractor would only have to satisfy ONE of these new criteria. The subcontractor therefore may have to make some small adjustments’ to his working practices to achieve compliance with just one of these criteria.

There are also other proposals to include in the new system all workers who provide their services through Managed Service Companies and Employment Agencies. Even workers operating through their own Limited Companies are not exempt as they will be required to operate PAYE on themselves if they do not meet one of the three criteria.

The Treasury have not given a date for the implementation of the new system but enigmatically say that the timing of the introduction of the new rules is critical which probably means as soon as possible. There is a consultation period up to 12 October 2009 and so it could be as soon as next April when these new rules come into effect.

The proposals will also have a VAT impact. Labour only sub-contractors at present are unlikely to be VAT registered but the requirement for one of the three criteria to be met, will undoubtedly increase the turnover so that it could easily reach the VAT Registration threshold thus creating a liability for them to register.

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