Public sector contractors who are deemed caught by the Off-Payroll tax rules and trade via a limited company face a unique set of accounting challenges but are encouraged to carry on using their limited company if they can.
Astonishingly, HMRC guidance on preparing statutory accounts when the Off-Payroll rules apply defies the fundamental rules of accounts preparation, leaving many contractors and accountants at risk of breaching the Companies Act 2006 and the applicable Financial Reporting Standard (FRS).
“Like many other aspects of the public sector roll-out, the mad rush to do something, rather than the right thing, trumped all other considerations,” explains Chris James, head of accounting at JSA Group. “Apparently, no one considering the changes noticed that it was impossible to prepare statutory accounts under the new rules, without breaking company law.”
Though James acknowledges the predicament in which many contractors find themselves, he notes that short-term solutions are available, and reminds contractors that continuing to trade via their company is essential to any successful challenge to their deemed Off-Payroll status.
Off-Payroll rules: the accounting conundrum for contractors
Where considered to apply, the Off-Payroll tax rules require that company turnover is invoiced and received by the contractor’s limited company. However, the sum paid is to be treated as personal income, with income tax and employee’s National Insurance (NI) having been deducted by the fee payer.
“When the contractor’s limited company receives this income, together with the VAT on the pre-tax sum, it isn’t the full value of the sales invoice issued by the company,” explains James. “It will also appear on the contractor’s personal tax return because tax has already been deducted via payroll.
“As per the Companies Act 2006 and FRS 102, this income is to be treated as company turnover. But, if you prepare accounts in this way, you begin with a taxable profit in the company on income that has already suffered tax deductions.”
HMRC’s guidance on the matter has been minimal, simply suggesting that income is treated as received by the limited company ‘on trust’ and passed onto the contractor either as an ‘untaxable dividend’ or treated as pre-taxed payroll.
James notes that there are no provisions within the Companies Act or the FRS 102 permitting income to be treated in such a manner, meaning the taxman is actively encouraging non-compliance with the rules:
“Usually a dividend would be taxable, but, in this instance, contractors are encouraged to treat it differently to other dividends; an action which isn’t backed by law. HMRC’s proposals don’t make sense with regards to financial reporting standards, which now require accountants to report turnover and taxable profit in instances where there are none.”
Contractors shouldn’t close companies due to Off-Payroll
“This issue wasn’t squared off because the Off-Payroll implementation was rushed, and, I suspect, because HMRC assumed anyone affected would just stop using their company,” adds James.
But, while the taxman may have anticipated mass limited company closures, there are plenty of reasons for contractors to continue working in this manner, particularly for those seeking to contest contentious status assessments.
“If a client deems you to be caught by the Off-Payroll tax rules and you doubt their assessment, closing your company and working through an umbrella isn’t going to help you prove your case if you appeal at a later date,” explains James. “Given the number of blanket assessments that we are hearing of, many contractors would be advised to keep trading through their company.
“Of course, a lot of contractors will have assignments that vary in type, meaning some work which falls within the scope of the rules and other work which doesn’t. Maintaining the company is always advised to help capitalise on the latter.”
How are contractors and accountants navigating the rules?
Pressure on HMRC to update its guidance is mounting. The Institute of Chartered Accountants in England and Wales (ICAEW) has asked that the issue is addressed as a matter of urgency, meaning amendments could soon be forthcoming. Until then, accountants are having to find creative ways to navigate the rules.
“Some accountants are using a version of common sense and not putting the payment to the individual through the profit and loss account at all,” comments James.“This way, the money ‘rests’ on the balance sheet until paid to the individual.This tactic is sensible in theory, but it is by no means a robust accounting practice.”
James observes that other accountants have opted to declare the income as usual, while reducing profits by the amounts paid out to the individual. Manual adjustments are then made to ensure corporation tax isn’t applied to the notional profit that the accounts would produce.
“Though this method prevents the contractor from suffering double taxation, it’s not ideal, as the amount paid to the individual isn’t being treated as usual. As a profession, we hate manual adjustments, namely because HMRC’s treatment of them isn’t documented, but also because we have no standards to hold them to.”
He adds: “In any case, many accountants have begun including an accounting policy note of their own, explaining how they have deviated from standard financial reporting.”
How can the Off-Payroll issues be addressed?
While contractors and accountants have adopted temporary methods to manage accounting complications, it’s clear that a long-term resolution is required. However, as the issue isn’t depriving the Treasury of any tax, whether HMRC views it as a priority is difficult to discern.
“Obviously HMRC needs to update its guidance, or at least launch a policy designed to decide which of the options currently being tried is the most suitable. But this still doesn’t deal with the problems with the accounts preparation rules. The only way to truly tackle these is through an overhaul of the Off-Payroll tax rules themselves,” comments James.
If a wider overhaul is to be considered, the notion of an ‘Off-Payroll tax’ would feasibly create far fewer complications than the current public-sector rules. Paid at a flat rate by firms engaging contingent labour, it would account for the employer’s NI shortfall that HMRC believes it is missing out on when an individual is engaged as self-employed.
Ultimately, it would achieve a similar tax yield to the Off-Payroll rules, without giving rise to false-employment, contested status assessments, and administrative and accounting complications, as acknowledged by James:
“It’s a simple idea, and generally only simple ideas work effectively. It would be easy to enforce and collect, especially if charged at a flat rate. The difficulties witnessed in the public sector regarding status assessments will be far more magnified in the private sector, so there are strong arguments to consider this idea, providing it doesn’t dramatically increase tax take.”
Government should pause before private sector change
Accounting problems are among several issues that have arisen in the public sector over the past year, yet all indications from HMRC point towards an imminent private sector rollout of the Off-Payroll rules. Despite this, James believes sustained lobbying stands a genuine chance of forcing Government to reconsider what would be a disastrous decision for UK plc:
“It would be very brave to extend these changes into the private sector.For HMRC to make out that the public sector rollout was largely successful is a very irresponsible tale to tell to justify such a huge disruption to a workforce, as we prepare to leave the EU. Especially one which provides the very flexibility that makes the UK such a good place to do business.
“Despite HMRC’s enthusiasm, I get the impression that parts of Government are very worried about the potential impact of a private sector rollout. It’s not a very conservative policy, and there was a lot of argument behind the scenes before the last Budget.”
James concludes: “With that in mind, if we continue to contact our local MPs, and present them with the facts about the impact of the Off-Payroll rules on the public sector, there is a good chance of stopping this in its tracks.”