Ask any contractor for their opinion on what HMRC thinks of contractors and they will probably scoff, laugh out loud or start to pace and rant incoherently. It’s safe to say that contractors have not been feeling the love from HMRC for a long time now and a reading of the runes from recent Hammond / May announcements and pronouncements would suggest that things aren’t going to be getting any better anytime soon, particularly for limited company contractors! How can we know this? Mainly because it is clear that both Chancellor Hammond and Prime Minister May are singing from the same song sheet – they both want limited company contractors, all self-employed workers in general and all employees alike to be paying the same levels of tax and the same levels of NIC’s if they are earning the same money. This is not the case right now and clearly, a change is a coming!
Contractors and Dividends – A Doomed Romance?
The first place they will perhaps want to start is with contractors who take the bulk of their money through dividend payments rather than through a salary. Every limited company contractor knows that this is the most tax efficient way to pay themselves and saves on tax and NIC’s. For Hammond and May this is unfair and gives them an advantage over regular employees earning the same amount. They want to change it and Philip Hammond is on record as saying that people should not choose to incorporate for tax reasons!
First They Came for the NIC’s
So the first step they were able to take was a national insurance increase for contractors. Their aim is to cut down the differential between salary and salary / dividends and they have started with an increase to type 4 National Insurance from 9% up to 11%. Additionally, they have also slashed the amount of the dividend allowance down to £2000 from the previous £5000.
Yet there still remains a significant differential between standard employees and those contractors working for limited companies. Which means HMRC and the chancellor will probably try again to decrease that differential. It is likely they will do this in small steps so as not to draw too much of an outcry, but in future, expect to see the gap between regular employment and limited company contracting close at each budget.
What Are They Aiming For? Total Parity in Tax and NIC’s.
As mentioned above, it is clear that the aim of all this is to achieve total parity in NIC’s and tax between regular employees and contractors who are earning the same money. With this in mind, it is fair to say that contractors in limited companies should be looking over their shoulders!
Imagining The Future? Look At Public Service Contractors!
For clues as to which way things are heading it is useful to look at what has been happening in the public sector. Why? Because in the public sector contractors are no longer able to decide their own IR35 status. Instead, it is up to the government department that hired them to designate their IR35 status, even though the people in that department will most likely not be experts in IR35 legislation and all its rules and implications. One negative consequence of this is that many government departments do not want the extra hassle of deciding on IR35 status and are consequently no longer hiring contractors who use personal service companies.
Public Service Contracts = Umbrella Companies?
There have been a lot of reports in the contractor press that these changes in the public sector have led to contractors walking away from the public sector altogether. However, in reality what is actually happening is that contractors who want to work in the public sector are being pushed into working via an umbrella company structure rather than through their limited company. It is either that or they are required by the government department to sit HMRC’s new IR35 test. Pass it and they can stay with their limited company. Fail it and they will either have to take off NIC’s and tax out of their income or alternatively they will be asked to join an umbrella.
Either way, taking the test could still see them trapped as the IR35 test could lead to them being investigated for previous contracts they have worked. Which is why more and more contractors are indeed moving over to umbrellas. Working through an umbrella company ends up less expensive than paying out on IR35 tax (even with the changes to subsistence and travel expenses. Isn’t it, then, something that every contractor should consider?
Moving from Personal Service to Umbrella Companies
Certainly, there are a lot of contractors making that move at the moment and moving from their limited companies over to umbrella companies. And they are becoming a genuinely popular option. Does this mean that HMRC are ok with them? Probably. Though technically HMRC still sees them as a vehicle for tax avoidance!
From Disguised Employment to Disguised Contracting?
IR35 was established so that HMRC could catch out all false employment, and to a certain extent HMRC thinks that umbrella companies are creating a new entity – disguised contractors. They act as contractors, but are paid as employees. Nevertheless, umbrella companies have the saving grace that they pay using PAYE and NIC’s.
Contractors Avoid Tax As Far as HMRC Are Concerned
It seems that at the moment HMRC have set their sights on contractors working via limited companies. Generally, May and Hammond see contractors across the board as being tax avoiders in one way or another, but for now HMRC seems to have settled on umbrella companies as their preferred way of dealing with things. After all it is far easier to deal with a few main umbrella companies than millions of contractors or thousands of limited companies! They trust umbrella companies to follow and implement any new legislation relating to contractor pay and see them as far easier to manage.
HMRC expect most contractors to fail their new IR35 test. They are significantly cutting the benefits of being paid by dividend and salary and will keep doing so. And they are pushing limited company contractors out of the public sector. It is clear that HMRC wants contractors to move into umbrella companies.
Is It The Same For Contractors In The Private Sector?
Contractors who work purely in the private sector are putting on a brave face and saying these issues won’t affect them but the evidence suggests otherwise. These changes are starting to appear indirectly as well as directly. For example, contractors who work for companies who do both public and private sector work are finding that they are being told to dump their personal service companies and move over to umbrella companies if they want to work with them. This is even in cases where the contractors are not doing any public sector work for them! In this way the government is managing to indirectly influence behaviour without having to actually legislate it, hitting any contractors who happen to work for companies who work with the government.
The general point to take away is that these changes are heading the way of all contractors, regardless. Hammond and May don’t want people to incorporate for tax reasons and they think that contractors shouldn’t have any tax perks over regular employees. It doesn’t take a huge leap of imagination to see that they are coming for the private sector contractors too!
Just Look at IR35 for Clues.
HMRC have been tightening the noose around the necks of limited company contractors for years now, ever since they introduced IR35 legislation back in 2000. Since then they have been widening the net on who falls within IR35 every couple of years, making the rules tighter and tighter, so they catch not only cases of disguised employment but also contractors who could be perceived as being working in false employment. And by laying down the IR35 rules for their public sector partners they are directly influencing the marketplace for contractors. Why would any business bother taking the risk of employing contractors who might get them tangled up in complicated IR35 issues?
Will Contractors Just Put Their Rates Up Then?
If they are paying more tax, the argument goes, then they will compensate by increasing their rates. Unfortunately it doesn’t work like that. The marketplace drives the rates that businesses are willing to pay. Make it too expensive and they will just stick with regular employees. So contractors will just have to stick to the same rates. And they will, inevitably, have to move over to an umbrella company.
The Future Is Umbrella Shaped
There’s no escaping it then, contractors are currently moving en masse to umbrella companies and with the rules on IR35 tightening year on year and the government applying pressure both indirectly and directly, there is every likelihood that most of the remaining limited company contractors will have to do the same in the not too distant future. They will certainly be better off in terms of avoiding problems with HMRC and they will get the added bonus of all the perks that come with umbrella companies (no paperwork, hassles etc.)