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Contracting experts clarify to Lords how contractors really work without avoiding tax

Contracting, small business and recruitment experts told the House of Lords Select Committee on Personal Service Companies (PSCs) exactly how contractors use personal service companies and why, during the third evidence-gathering session.

“This was the best session so far and the panel conveyed very well to the Lords exactly why independent professionals use limited companies to conduct their business, and why they are such a valuable way of working for UK Plc,” says ContractorCalculator CEO Dave Chaplin.

And from the outset, witnesses made it clear that highly skilled and highly paid contractors should not be confused with vulnerable low skilled, low paid temps. It is contractors who are in the driving seat, not the agency or the client, confirmed the witnesses.

Why do contractors use PSCs?

Committee chairman Baroness Noakes opened the session by asking the panel of witnesses from contracting and business organisations why people work through PSCs and whether some individuals are encouraged to work through particular structures.

In response, the Association of Professional Staffing Companies’ (APSCo) head of external affairs Samantha Hurley made it clear that “the recruitment company has very little power in the relationship”. She explained that contractors have generally already decided to use a PSC, or umbrella, before they even speak to the agency.

Martin Hesketh, managing director of Brookson and representing the Freelancer and Contractor Services Association, noted that “most recruitment agencies are uncomfortable with engaging contractors on a self-employed…basis”.

He added that this was because of the risks that the recruiter might be liable for unpaid tax if paying the contractor gross, but also said that there is “no evidence that PSCs are being used on an industrial scale to avoid tax”.

84% of PCG members use PSCs for reasons other than tax

Highlighting that PCG’s membership surveys confirm that 84% of limited company contractors use PSC for “reasons other than tax”, CEO Chris Bryce notes that: “Just like any other businesses, there are clear commercial reasons for freelancers to use limited companies.

“It separates business assets from personal assets, makes it simpler to negotiate with other freelancers with regards to subcontracting arrangements, [and] most, if not all, agencies – and some clients in fact – insist that freelancers use a limited company.” He pointed out that agencies will not engage with them otherwise, meaning freelancers that do not work through limited companies “will be unable to bid for a significant proportion of available contracts”.

The Federation of Small Business’s (FSB) taxation and financial affairs chairman David Ramsden, pointed out that he did not recognise the term ‘personal service company’, and maintained that “you are either a company or not a company”.

Defining self-employment

One member of the Lords committee found it odd that, despite having visited this topic on numerous occasions in the past, they kept encountering stumbling blocks and there should be a simple way of defining whether or not someone is self-employed.

“It’s a classic case where common sense tells us all that it should be a simple thing to do,” observes Chaplin, “but when you look at it and the many years of employment case law on which a simple test should be based, the answer is that it is not that simple.”

Ramsden pointed out that there is an easy answer, which is to enshrine the right to be self-employed in statute, allowing people to choose. He also explained that HMRC fails to understand that knowledge and skills are a saleable product, in the same way that someone makes and sells cushions as a business. HMRC adopts a default position that every such worker is a disguised employee.

“The problem is that HMRC does not like people paying less tax than employees,” continues Chaplin, “and the taxman comes along with legislation like IR35 and the new false self-employment test saying, ‘oh no, you’re not [running a business]’.”

Legislating for flexible workers: experts split over IR35

The consensus across the panel was that contractors are a distinctive subset of the flexible workforce according to their level of skill and pay, although Bryce explained that an increasing number of younger workers and new graduates were turning to freelancing.

Hesketh identified that HMRC has a challenge legislating across the whole flexible workforce of 1.5m to 2m workers. He told the Lords that this population is not homogenous and spans low income, low skilled vulnerable workers at one end, with contractors running a business at the other. He acknowledged that the challenge facing HMRC and government is to protect the bottom whilst not constraining and curtailing the top end.

However, on the topic of IR35, the panel disagreed. Hesketh felt that it should be maintained and that enforcement activity must be increased, alongside greater education among the small business community and flexible workforce.

Ramsden countered by stating that the legislation in place at the moment renders IR35 unnecessary, that IR35 collects little additional tax revenue and so should be abolished.

Bryce agreed, saying: “The simple fact is, IR35 is outmoded and unnecessary. We, along with the Federation of Small Business, seek its abolition and the Office of Tax Simplification has called for its suspension.”

Have the new IR35 measures introduced in May 2012 been effective?

Baroness Noakes closed the session by asking the witnesses a final question: “Have the changes made by HMRC last year worked well, and if you could change one thing, what would you change?”

  • Hurley brought up the business entity tests, saying that in their original form, they were a great idea and an effective IR35 risk identifier. However, APSCo is “concerned about people in the public sector where many departments are using the business entity tests to decide whether someone is inside or outside of IR35”.
  • Hesketh advocates that HMRC should be braver about supporting good practice and condemning bad practice: “HMRC never quite condemns the bad stuff publicly and openly, and equally does not advocate and support good practice.” He believes a fresh approach could “make a big difference to behaviours in the marketplace”.
  • Ramsden’s view is that the IR35 Forum, of which he is a member, is a “box-ticking exercise” and that HMRC suffers from a ‘not invented here’ attitude. This has resulted in many good initiatives of the forum, such as the business entity tests, being released only when HMRC has stamped its mark on it.
  • Bryce criticised HMRC’s lack of transparency and the difficulty of obtaining figures and facts. But he said PCG is very pleased with the speedier processing of cases and the release of statistics.

Despite the strong evidence supporting contractors presented by the panel, Chaplin’s fear is that the inquiry will produce a report saying how things currently are and how they are working, without making meaningful recommendations. “The danger if that happens is that people with the power to change things for the better will read the report, and then do nothing,” he concludes.

Published: 18 December 2013

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