Chancellor of the exchequer George Osborne’s summer budget was pitched as a budget for working people. But does that mean all working people, or just employees in a certain wage bracket?
Whatever the answer, one thing is certain: IT contractors will not be happy because, mixed in with the rhetoric and numbers and the by-now familiar promises to crack down on tax avoidance and evasion, there was talk of “addressing imbalances in the system”.
The reality of the budget is concerning, says Jason Piper, technical manager for tax and business law at the Association of Chartered Certified Accountants, because there seems to be a trend for levelling out the financial burden across the board, so that everyone pays the same taxes as employees on their income, even if they don’t get the same state benefits.
The biggest shock came from changes to the dividend regime. From next April, there will be no more grossing up of dividends and claiming back of a notional credit; instead, taxpayers get the first £5,000 tax-free, then pay tax at increased rates on the balance. “In practice,” says Piper, “even after the £5,000 tax-free allowance, the loss of the tax credit means more tax will be paid overall.”
It is this rise in taxation that is bothering Jordan Marshall, policy and external affairs adviser at the Association of Independent Professionals and the Self-Employed (IPSE). He sees it affecting not just contractors, but anyone who works through a limited company, because “directors will be forced to pay 7.5% more tax on any dividend payments”.
Marshall considers this as little more than a tax on entrepreneurship. The rate is 32.5% at the higher rate band and 38.1% at the additional rate band.
Piper illustrates what the changes mean. He reckons the changes will not affect a company making profits of less than £18,000 – a non-issue for any decent IT contractor – and with the true costs of running a company, that is also likely to be the case for contractors generating profits up to around £40,000.
The chancellor’s changes have moved the “break-even point for tax” to nearer £70,000 of profit, says Piper. With average daily rates of pay for an IT contractor skilled in, say, cyber security of around £450, an income of around £110,000 a year makes for interesting calculations.
Piper notes: “Beyond a profit of £70,000, the combined impact of corporation tax changes and the new, higher dividend rate actually see the tax benefits of incorporation starting to fall again. Here it might be more tax-efficient to operate as a sole trader.”
This is, of course, aside from the argument that corporations seem to like to deal with incorporated contractors.
The only ray of sunshine, says IPSE’s Marshall, is the cut in corporation tax to 19% in 2017, with a further cut to 18% by 2020. He considers this as positive news for those operating a limited company.
Triple lock, but…
But while the headlines revolve around the taxation of dividends, there are other changes in the pipeline. The chancellor’s “triple lock” should hold VAT, Class 1 national insurance contributions (NICs) and the main income tax rates steady, but, says Piper, Class 4 NICs are not bound by that.
So, if the chancellor decides to align Class 4 NICs with the Class 1 employee rate, that would move the pendulum slightly back towards incorporation again. He adds: “The one thing you mustn’t do [in reaction to the budget] is make changes without taking good professional advice.”
If, until now, you have qualified for the NICs Employment Allowance, you may not from next April because sole-director employees will be disbarred, and there will be anti-avoidance provisions in place to stop the obvious workarounds, such as employing additional family members.
Piper adds a note of caution for those who may try workarounds: “Burdens like pensions auto-enrolment and demonstrating national minimum wage compliance, and the like, make taking on employees unnecessarily a pretty unattractive prospect for small businesses.”
One area the government has long been worried about is "disguised employment" and this is something that the IT sector should be well aware of. Until now, the tax burdens on a self-employed labour relationship, or contracts with a company, have been so much lower than on employment relationships as to make it attractive to try to dress employments up as business contracts. The incorporation route is costing the chancellor dear.
So, to make false self-employment less attractive, the government is going to clamp down on travel expenses. Piper reckons that while it is theoretically aimed at agency workers who are claiming their daily commute on a tax return in a way that employees specifically cannot, it will almost certainly catch a lot of others.
“The proposal is that anyone who is employed through one company but subject to a (theoretical) right of supervision, or direction, or control by another third party will be treated as if employed by the third party for travel expense purposes,” he says.
“That means that a contractor working on a project, at times decided by the ‘employer’, and in a way that it determines, will find that travel costs to and from ‘work’ will not be allowable.” The bar is set low and contractors will get caught up in this.
These changes are also of concern to IPSE, and Marshall is not happy. “This threatens the very way in which independent professionals work – severely limiting their ability to deliver flexible expertise and putting them at a huge competitive disadvantage to big consultancies and European competitors,” he says.
The argument is one that revolves around the legitimacy of the expenses which, to Marshall, is proven.
And while the much-hated IR35 tax legislation that is designed to catch disguised employment is finally up for a fundamental review as well, there is no good news here either. Piper thinks the review may not necessarily pan out the way small businesses might want it to.
“HM Revenue & Customs is talking to lots of interested parties about how to fix legislation, rather than just trying to improve administration,” he says. “But one clear message we’re getting is that ministers are standing by the figure of £400m a year ‘tax leakage’ around IR35, and they see it as their responsibility to try to stem that flow.”
But can IR35 be made more effective? Possibly, but Marshall reckons, like Piper, that in reality, the review could lead to tightening up the rules around IR35, which could move liability over to clients. For him, the removal of IR35 would be a better option. “IPSE has consistently called for IR35 to be abolished and we will again use this latest review to point out the obvious flaws in the rules,” he says.
According to Piper, the main worry here is that some of the suggested IR35 proposals, which aim to put more of the burden on larger businesses when they trade with smaller ones, could drive big business to treat all small companies as a risk to their own tax compliance record, which would not be to anyone’s advantage.
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Marshall sees tough times ahead. “Travel and subsistence changes threaten the way contractors are able to work flexibly,” he says. “All of these measures will mean they would no longer be on a level playing field with big consultancies. And further changes to IR35 to put an onus on the end client could create problems.”
So, all in all, it doesn’t look like it’s been a great budget for IT contractors. The changes are complex and fiddly, and there are no great giveaways that you can access just by filling out a few forms. Experts recommend taking good, early professional advice.
Marshall adds: “We urge everyone to join us and write to your MP, pointing out the potential damage these measures may cause to your business and to the UK’s flexible economy.”
More changes are bound to come in the future. But what will they be? Time to get out the crystal ball.