What are they?
The new agency tax rules came into force on 6 April 2014 following a brief consultation with interested parties that ended in March. They are designed to tackle what the Government and HMRC perceive to be “false self-employment” within the recruitment industry.
It is not just the construction industry that is affected, but it is one of the main targets of the new agency rules, as the Construction Industry Scheme (the CIS) is often used as a kind of unofficial substitute for PAYE in the mistaken belief that anyone working in the construction industry can be registered as a sub-contractor.
By paying workers through the CIS scheme, the agency is only obliged to deduct a flat 20% from their earnings and expenses, rather than treating them as employees and operating PAYE on their earnings. The workers get no employment rights and are left to deal with their own tax affairs under Self-Assessment. Moreover, the hirers do not have to pay Employer National Insurance.
Often, sole trader status is more or less forced on the individuals concerned, who may not have shown any inclination to be self-employed before then, and justified for tax purposes with “dodgy” substitution clauses that would never be entertained by the Client in practice.
Who is affected?
The new rules only apply to staff agencies and other recruitment or payroll organisations. They apply to workers who provide their services to a person (the Client) under, or in consequence of, a contract with a third party (the Agency). They do not affect workers engaged directly by the Client, so if an agency merely introduces the worker, the new rules do not apply.
Although it is mainly the construction industry that is affected (due to long-running abuse of the CIS scheme in the eyes of the Government) other sectors may also be caught by the new rules.
How would I be affected?
If you are currently engaged by an agency as a sole trader on the CIS scheme, you receive your earnings net of a 20% deduction towards tax and Class 4 National Insurance. Class 4 NI is 9% of your profits for the year. Under the new agency rules, your self-employed status will disappear unless you can avoid the rather onerous SDC regulations (Supervision Direction and Control).
If you cannot avoid SDC, the agency must engage you as an employee, which usually means working through an umbrella company. In turn, that means being paid under PAYE rather than CIS. You will also be entitled to employee rights such as holiday pay and auto-enrolment into an occupational pension scheme. However, this will have to come out of your own earnings unless the agency can persuade the end-user (the Client) to pay more than it did before.
As an employee, you will pay Class 1 NI which is 12%. However, the umbrella company will also have to pay 13.8% Employer NI. As the only income the umbrella company gets is your pay, guess who is going to pay the 13.8%. One of our latest clients told us he would have been taking home £200 a week less under the new rules, and almost certainly this was down to Employer NI. Some of it was probably due to umbrella company fees too.
Am I subject to SDC?
Good question! It is not a new concept as it reflects previous HMRC policy but it is the first time it has been put into legislation, so no one is really sure how at present the SDC rule will operate in practice. However, it does sound more stringent than the principles established down the years by the courts to determine whether someone is employed or not. So what exactly is Supervision Direction and Control?
HMRC give 12 examples in their SDC guidance notes to illustrate how they believe it should apply. They have made some very fine distinctions in these examples, which cover a broad range of occupations, not just the construction industry. However, this detailed guidance is merely the HMRC view of how the legislation should be interpreted. In itself, it does not have the force of law, although it may well turn out to be definitive. Obviously, at this early stage there is no case law to fall back on for the SDC test, so the HMRC guidance is all we have at present.
It is important to remember that you can be caught by the SDC rule even if no SDC is actually exercised. It is sufficient that there is merely a right to exercise SDC over your work. Moreover, it is not even necessary for the hirer itself to exercise SDC. For example, control of the work may have been out-sourced to a third party so that SDC is exercised by someone working for a different firm.
In fact, according to one of the HMRC examples, merely having to follow laid down procedures would be enough for SDC to exist, even if no one actually supervises or directs you. However, merely having to comply with legal requirements, such as Health and Safety regulations, is not sufficient on its own for SDC to exist.
The new rules are very unfair on real sub-contractors who are in business on their own account and would be regarded as self-employed under existing case law. Under the new legislation, the SDC test is the “be all and end all” as far as agency contracts are concerned.
Can I avoid SDC?
In theory, it is possible for an agency to accept a statement from the Client that no SDC is present in an assignment right at the outset. In reality, most clients would probably be very reluctant to stick their necks out like this, as the legislation then makes them responsible for the outstanding PAYE liabilities should they turn out to be wrong.
It is the responsibility of the agency to decide whether SDC exists in a contract and the onus is on them to prove that it does not if they fail to treat the worker as an employee. Most agencies are likely to play safe and require any workers they engage for their clients to be paid through an umbrella company, which will deduct PAYE from their earnings.
Is there an alternative?
Yes, you can opt to work through your own personal service company (PSC) instead. HMRC have confirmed that a PSC will not be subject to the new rules if its income from the contract is taken as salary, dividends or loans. They have hedged their bets a bit here by saying they would not be affected “under normal circumstances” but their position here seems clear enough.
With a PSC, you get to choose how you take money out of the company. The normal set-up is to take a small salary and high dividends. This has the effect of reducing or eliminating NI contributions altogether whilst still retaining your entitlement to state benefits and pension. The company pays 20% corporation tax on its profits before dividends are taken whilst you pay no income tax on the dividends at all unless your total income for the year exceeds the higher rate threshold.
In addition, you can control how much money you take out of the company. For example, you may wish to limit your income to £50,000 so you don’t pay tax on your Child Benefit. You can do this simply by limiting your dividends and retaining the untaken profits in the company.
There are other benefits to working through a company too. To list them all here would require a mini-guide all of its own, but probably the most valuable one to those who are parents is tax free Childcare Vouchers worth £243 a month. These can be used for various activities until a child is 16 years old. They are not just for nurseries.
Are there any snags?
Yes, you need to watch out for IR35. This is another tax rule which has been on the statute book since April 2000 and was brought in to combat “disguised self-employment”. Basically, it aims to treat all income received by the company from “relevant engagements” as taxable under PAYE as though the worker was employed directly by the Client.
In that sense, it is similar to the new agency rules except that the onus to comply with IR35 is on the worker, not the agency or the client. If you fall foul of IR35, you are supposed to declare it on your annual PAYE returns and voluntarily pay the extra tax and National Insurance due.
Unsurprisingly, many PSC owners decide that their contracts are outside IR35 and choose not to pay the extra tax and NI. It is then up to HMRC to challenge that if they believe they have any sort of a case.
On a more mundane level, you would have to set up a bank account for the company, prepare weekly or monthly invoices for your fees and file annual accounts at Companies House.
Should I be worried by IR35?
Possibly but not necessarily. The good news here is three-fold. Firstly, it is a lot easier to avoid IR35 than it is to prove you are not subject to SDC. There are other factors that tax tribunals take into account apart from control of the work when deciding if IR35 applies or not.
Secondly, not that many people up to now have been investigated under IR35. HMRC seem to rely on its deterrent effect more than anything. In fact, they only opened 23 enquiries during the 2010/11 tax year according to official figures released under the Freedom of Information Act. They also lose a fair number of the IR35 cases brought before the tax tribunals.
Thirdly, even if you lose an IR35 case, it is unlikely that HMRC would expect you to pay the tax and NI owed by the company personally if it had insufficient cash. Dividends already taken tend to be safe, so long as you declared them properly and were not totally cavalier about IR35.
There is also a clearance procedure for IR35 whereby you can ask HMRC to assess your contract. However, they will only do this if the contract is already signed, not on a “what-if” basis. This would at least provide some certainty, but of course, if they say that your contract is caught by IR35 you would have to either challenge it or abide by it, so to that extent it is a leap in the dark
What about the TAAR?
The more well-informed will have heard there is a Targeted Anti-Avoidance Rule (a TAAR) in the 2014 Finance Bill aimed at personal service companies. This states that the new agency rules will apply if one of the main reasons for a company being set up was to avoid income tax.
However, the good news here is that the TAAR is targeted at the agencies themselves, not at the individual workers. It is to stop agencies from herding their contractors into personal service companies en-masse in an attempt to dodge the new tax rules.
Would I still be in the CIS scheme?
No, as you will now be an employee of your own company. However, it is more than likely that your company will be a sub-contractor under the CIS scheme if you are still doing the same work. In that case, you will need to phone the CIS helpline to register the company instead and notify the agency of the company tax reference.
The agency will then have to deduct 20% tax from your earnings as before and the company will deduct this from its corporation tax bill at the end of the year. It will get a rebate if the deductions exceed its tax bill. Alternatively, if annual earnings exceed £30,000 it can apply to be paid gross.
Would I need to register the company for VAT?
Only if annual turnover exceeds £81,000 (the 2014/15 registration threshold) although that would have been the case for you as a sub-contractor too. If your annual turnover is less than £81,000 you can register voluntarily for VAT and it may well be beneficial for you to do so.
Why is VAT registration beneficial?
Because you can claim back the VAT paid on goods and services purchased for your business, such as tools and accountancy fees, against the VAT you charge the agency and only pay HMRC the difference. Effectively, you save one-sixth of the cost of these items, although you might do even better on the Flat Rate Scheme.
Why might the Flat Rate Scheme be better?
Because you charge your clients 20% VAT but only pay a flat rate of 14.5% to HMRC on the total amount invoiced to the agency. You can keep the difference. However, the downside is that you must forego any VAT you would have been able to re-claim on goods and services purchased, so you need to deduct this to work out the true saving.
The Flat Rate Scheme is designed to be tax-neutral, but most businesses with low overheads do well on it. For example, a business turning over £70,000 a year with purchases of £2,400 would gain £1,420 per annum on the scheme. For Year 1 the gain would be £2,260 as you get a 1% introductory discount on your flat rate.
It gets even better if the cost of materials is at least 10% of your turnover, as then the flat rate goes down to 9.5%. In the above example, if materials cost £7,000 plus VAT you would lose £1,400 but gain an extra £4,200. This may even be enough to offset any extra tax and NI payable under IR35. Of course, it assumes the client or agency would allow to you supply materials.
Always get advice from an accountant before applying for the Flat Rate Scheme though, as sometimes it may not be to your benefit, particularly if you have a high level of overheads or make lots of exempt or zero-rated supplies.
How can we help?
We can set up a company for you, register it for all taxes, advise on the optimum level of salary, expenses and dividends, do all the VAT returns, file accounts at Companies House and prepare your corporation tax return, your personal tax return and all the other compliance work, for a fixed annual fee.
Please see our Gold, Silver and Bronze packages for fees of between £80 and £120 per month plus VAT. Then call us on the numbers below, send us an email or fill in the Enquiry Form on our Contact Us page. Very soon, the new agency tax rules may start to look like a blessing in disguise.
We can also do your final sole trader accounts, prepare and file your tax return for the previous year and obtain any CIS rebates you are entitled to.