Limited company and umbrella company contractors have been deliberately excluded by HMRC from the proposed False Self-Employment legislation by a tax technicality.
This is according to an analysis by recruitment and contractor legal specialists Lawspeed, who presented their findings to an audience of recruiters and contracting sector stakeholders in its recent seminar under the banner, Is contracting under threat following government tax proposals?
ContractorCalculator CEO Dave Chaplin, who attended, believes that limited company contractors are not the intended target of the proposed rules: “It became clear during Lawspeed’s analysis that HMRC is targeting mass-marketed self-employment schemes, and not independent professionals trading via limited companies.”
What the existing legislation says
According to Lawspeed, Section 44 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) currently says that a worker must pay income tax and NICs via Pay As You Earn (PAYE) if:
- The individual is under obligation to provide personal services
- The contract is via a third party agency contract
- The worker is subject to supervision, direction and control as to the manner the services are provided
- The payment would not otherwise be employment income.
All of these conditions must apply to the worker’s situation, otherwise they can be paid gross by the agency.
The new legislation proposes to change these rules to three amended conditions that must all must apply if the worker is to be paid via PAYE. However, a key new condition has been introduced by HMRC, which says that PAYE applies if the agency cannot show there is no supervision, direction and control as to the manner the services are provided.
The new conditions under the proposed legislation
Lawspeed explains that the obligation to provide personal services is replaced with: “the individual personally provides, or is personally involved in the provision of services”. Under the old rules, if a contractor sent in a substitute the provision could not apply, so they could be paid gross by their agency.
But selecting and paying a substitute now qualifies as being ‘personally involved’ in providing the services. So, the new rule means that in this context, substitution is no longer the ‘silver bullet’ it was once considered to be, although of course substitution does still apply to IR35.
It will be almost impossible to demonstrate that some sort of supervision, direction and control does not apply
Ben Grover, Lawspeed
The reference to ‘agency contract’ has also been removed, and replaced with a new clause saying that ‘any third person’ is now defined as the agency. This could continue to mean the recruiter, but could also mean that a contractor’s limited company could be the ‘third person’.
‘Remuneration’ is the key word for limited company contractors
So far, it may be possible for a limited company contractor to satisfy the first two new conditions. However, Lawspeed highlights that it is the third condition that excludes PSCs, and therefore limited company contractors, through a tax technicality. It also excludes umbrella contractors.
The third condition says, “if remuneration receivable under or in consequence of the agency contract is not otherwise already treated as employment income” then the worker must have income tax and NICs deducted by the ‘third party’ via PAYE.
Lawspeed’s analysis is crucial here, identifying the legislation changes saying that, “if already employment income or otherwise not ‘remuneration’ as defined (section 47) the condition is not met”.
Umbrella company contractors already receive their fees as employment income, paying income tax and NICs via their umbrella company’s PAYE scheme, so the condition is not met and the proposed new rules would not apply. Limited company contractors who are paying themselves via a salary or deemed payment are also receiving employment income, so they are also unaffected.
And limited company contractors who pay themselves mainly via a dividend do not meet the requirement of the condition because the dividend does not qualify as remuneration according to the definition in section 47. This is because there is no direct link between what the agency pays the PSC and what the PSC then pays the worker.
What has happened to control?
The old condition three, requiring HMRC to prove that the worker is controlled, has been removed. That’s not because control is no longer a factor. It is because ‘supervision, direction and control’ (SDC) are now presumed by HMRC to exist.
The burden is on the third party, or agency, to prove that control does not exist. “It will be almost impossible to demonstrate that some sort of supervision, direction and control does not apply,” notes Lawspeed’s Ben Grover on this point.
Lawspeed managing director Adrian Marlowe is understated on this point: Proving that something does not exist is “quite difficult”, he says.
Nightmare for agencies and construction clients, but contractors remain unscathed
According to Chaplin, Lawspeed’s analysis highlights it is likely the construction sector will suffer considerably by the new rules. Recruiters and construction clients who want to hire self-employed sole traders have a potential nightmare on their hands, he says.
“The rules could hit the recruitment and construction sector in two ways,” Chaplin notes. “Firstly, how can agencies and construction firms keep track of potentially tens of thousands of soles traders and prove they are all free of supervision, direction and control?
“Secondly, Lawspeed estimates that about two thirds of self-employed sole traders in the construction sector are genuine, and may have already demonstrated their business credentials by complying with the construction industry scheme (CIS). The legislation in its current form is so far reaching that all those legitimate sole traders may be swept into PAYE, despite being genuine businesses.”
The construction sector is already suffering from skills shortages as activity increases following the recession. Chaplin fears that many highly skilled tradespeople may simply leave the sector to escape the high compliance burden, potentially putting the brakes on the UK’s economic recovery.
Chaplin concludes: “Lawspeed’s analysis should enable the contracting sector to breathe a collective sigh of relief. However, despite the good news that contractors are unlikely to be affected by this legislation, no new tax legislation is to be welcomed, particularly as these rules will place a huge additional burden on recruiters and other businesses.”