From The Times - March 31 2007
Limited Options for Contractors
Elizabeth Colman on the rule changes that hit freelance workers who have set up as companies to cut their tax bills.
It seemed like easy money for about a quarter of a million contractors and freelance workers. For a small fee, a service provider created a limited company, helping the worker to save up to 30 per cent on his or her tax and national insurance bill.
The Chancellor, however, had different ideas and announced in the Budget that, from April 6, managed service companies will attract the same tax rates as PAYE employees. Limited companies linked to a managed service provider will also be liable for national insurance contributions (NICs).
At present the schemes allow a contractor to be recast as a shareholder and paid in dividends, which are subject to tax rates as low as 19 per cent. As shareholders, they are also exempt from national insurance contributions.
Sharon Boxall, of KPMG, the accountant, says that workers paid through a managed service company should contact their service provider immediately. "The worker needs to find out what happens now," she says. "Perhaps he or she should use an umbrella company or a personal service company."
Umbrella companies do not attract a lower base rate of income tax, but they can offset travel and other expenses against tax bills. Adrian Marlowe, of Lawspeed, the business legal service, thinks that many managed service companies will convert to umbrella companies.
All the alternatives available to contractors who wish to remain in a limited company involve workers taking more control over their financial affairs, including signing their own accounts and receiving payments into a bank account in their own name. Furthermore, the managed service provider must prove that it is providing purely "accounting" or "legal" services to the company and not otherwise "influencing" it.
Barry Roback, of JSA Group, which offers a range of accounting and financial advice services, including managing service companies, says that the new requirements will not suit all workers.
Mr Roback says: "I have a client who is a contractor on £250,000 a year, at a day rate of £1,500. She does not want to have to manage her own affairs. What difference does it make if we sign her accounts after showing them to her and send them to Companies House? The Treasury seems to think that unless you wear an overall and have a box of spanners, you are in conventional employment."
The Treasury's view is that managed service providers have made it too easy for contractors to form a company. In 2002-03 there were an estimated 65,000 managed service companies. Some experts say that the figure was approaching 500,000 before the measures introduced in the Budget. The Treasury predicts that its crackdown will bring in £1.5 billion in revenue over the next three years.
To drive home its message that managed service companies are to be discouraged, the Revenue may hold the provider or "end-point employer" liable for any unpaid tax found to be owing by a managed service company.
Factfile Managed Service Companies
These pay workers in dividends, which are taxed at a lower rate than income. But after the Budget changes these will now be subject to PAYE tax rates and national insurance contributions.
Umbrella Companies
Unaffected by the Budget. Companies can still offset travel costs and general expenses against their tax bills.
Personal Service Companies
Unaffected by the Budget. Taxed at company rate and exempt from national insurance. Workers must prove that they are self-employed.
CASE STUDY: In Good Company
Before Rob Curtis's employment agency found him a job, it set about finding him a tax break. Mr Curtis was given a list of "preferred providers" to help him to set up a managed sevice company.
The 26-year-old psychology graduate, who now works as a consultant to the public sector, has saved £140 a week in income tax and national insurance. "It is an attractive option, especially when you are saving money," he says.
Mr Curtis was aware of the forthcoming changes to the scheme and contacted Sagen Tax, which created a personal service company for him.
"Sagen is setting me up as a director of a company, instead of a shareholder," he says. "I will be responsible for transferring money back into my own account - I can no longer expect someone else to manage it for me completely."
Mr Curtis, who arrived in Britain from Australia last year, doubts that he could manage without the savings and adds: "It would mean a significant reduction in pay - enough for me to consider going home."