The way contractors pay tax is changing – what you need to know
The changes to Travel & Subsistence (T&S) tax relief were widely expected by the industry for some time but draft legislation was not released until 9th December 2015 and the final wording wasn’t released until the 16th March 2016. The Finance Bill 2016 comes into effect on the 6th April 2016.
The aim of the legislation is to rebalance the taxes paid by permanent employees, temps and contractors. At the moment temps and permanent employees are unable to claim expenses for their normal commute to and from work. They are also not able to make any subsistence claims, including accommodation costs. Umbrella and Ltd company contractors can claim these expenses as part of the cost of working in a “temporary workplace” therefore reducing their tax liability.
The different tax models currently used
Permanent employees / Temporary staff – PAYE, no expenses allowed
Umbrella company contractors – PAYE deductions are made but tax relief can be claimed for T&S
Limited company contractors (AKA Personal Service Companies or PSCs) outside IR35 – Contractors typically pay a nominal PAYE salary. Other income is paid in the form of dividends after business expenses (including T&S) have been paid. They also have to pay corporation tax on company profits.
PSC contractors within IR35 – Tax is paid at PAYE levels but expenses are allowed
So what’s wrong with the current company model?
Well, the government feels that contractors aren’t paying their fair share of tax and that they may not be “legitimately” self-employed. HMRC estimates changing the rules on T&S will affect 430,000 workers and generate £155 million in additional tax in the first year alone – there is a lot at stake!
Who will these changes affect?
Anyone working through an umbrella company, personally provides the services (ie are not using subcontractors or their own employees) and who is subject to supervision, direction and control (SDC) will no longer be eligible for tax relief on T&S. This will also apply if the end client has the right of SDC. Contractors working through a PSC, but within the scope of IR35, will no longer be able to claim T&S relief. PSC contractors who fall outside the scope of IR35 will be unaffected.
What is supervision, direction and control?
SDC is something that is going to become VERY important in the world of contracting. It is used in a variety of contexts within the contracting industry but for PAYE purposes it has been defined by HMRC as:
Supervision – There is oversight of the work done, or help or training given
Direction – Where instructions, guidance or advice is given
Control – Where someone dictates what, when and/or how the work is done
As is common with HMRC when it comes to tax legislation, this is suitably vague. This is kind of the point of the legislation though as HMRC wants everyone to pay tax on a PAYE basis. There isn’t really a set test contractors can use however the FCSA suggest that it will be the manner in which the work is actually done rather than the guidance given by the end client at the start of a role. It is important to note that HMRC will automatically assume that SDC applies and any contractor will have to prove a negative.
Is there any way I can keep claiming T&S expenses?
Yes, there are a few ways you can, for example if you are using a PSC and are outside of IR35. Also, if you work on two or more sites then one will be designated as a temporary workplace (which ever you spend the least amount of time working at) and travel and subsistence would be allowable in relation to that work.
There is a rumour that people working at rates of £15 per hour our above may be considered outside of SDC, and therefore still able to claim T&S. I have been speaking to various umbrella companies and accountants over the past few weeks and some are suggesting they will interview contractors to determine that they are not under SDC. In my opinion, this may be a risky strategy should that assessment be found by HMRC to be incorrect. If a contractor has given false information during this interview then some tax liability will fall on them. Should the umbrella company make the wrong decision then the tax liability will fall on them, but would they look to recoup those losses? Should the interview take the form of a box-ticking exercise then there is greater risk of the wrong decision being made.
Some umbrella companies may be able to obtain approval for fixed cost expenses to be deducted under S289A of the Finance Act. This can only apply for fixed costs and would not be allowed to vary month on month. There would need to be a paper trail proving that the costs are actually being incurred and are a reasonable estimate. You cannot over-claim and if the amount claimed was found to be incorrect then back taxes would be owed.
If an umbrella company tells you that you don’t need to worry, that you can continue claiming T&S relief be careful. Without proof from the end client of SDC not applying, an umbrella company should not claim tax relief for you. Recruitment agencies will not be able to make a decision on the end client’s behalf. The end client is highly unlikely to sign anything saying that SDC doesn’t apply as it transfers any unpaid tax liability to them.
What effect will this legislation change have?
According to an FCSA survey just 35% of hirers were fully conversant with the changes. This is largely because they will not be immediately, directly affected. The survey also showed that a massive 95% of respondents believe that an element of SDC will apply to their contractors. Despite this, just 8% said they would increase their pay rates and a further 7% said they would consider a rate change on a case by case basis. If end clients begin to struggle to hire contractors though this may well change.
Traditionally contractors are a very flexible work force and are willing to travel further than permanent employees would consider, largely because they are able to recoup the cost. This legislation will probably mean a drastic reduction in this flexibility, diminishing a vital resource for UK Plc.
There is an expectation that many affected contractors will switch to a PSC. This was anticipated by HMRC but they massively underestimated the volumes involved, even before the change comes into force. The knock-on effect of a mass-switch is lower tax revenues for HMRC and in the budget it was announced that HMRC will start aggressively reviewing IR35 legislation and PSC taxes. It’s anticipated any changes will come into effect by April 2017. This may well be in the form of the SDC being applied to IR35 but that is as yet unknown. Another suggestion is that recruitment agencies will be forced to make some tax deductions at source.
It is also worth mentioning that dividend changes for PSCs come into effect from April 2016 so making a switch may not be the quick fix it seems.
What if I don’t want to switch to a PSC?
You don’t have to. Many umbrellas are releasing their updated services and most will continue to offer an umbrella model, you just may not be able to claim T&S relief any more. According to the FCSA, 40% of contractors don’t actually claim expenses anyway so they will remain unaffected. If you are not claiming relief or only minimal relief then it may not be worth the change.
If you run a PSC within IR35 then you will have to stop claiming tax relief but will be able to continue working as a PSC. If you run a PSC outside of IR35 then you can carry on as normal for now.
I am not an accountant and I strongly recommend that you talk to your umbrella company and an accountant about the different options available to you. No-one wants to pay more tax than they have to, but you also don’t want a big tax bill further down the line!
Victoria Watkins is Office Manager here at Corriculo Ltd. After working as a Recruitment Consultant for 5 years she moved to Office Management for an IT consultancy 7 years ago. Victoria was one of the first members of our team and deals with all of our administration and accounts. Connect with her on LinkedIn, Twitter or Google+
Originally posted 14/3/16. Updated 23/3/16