In the past, providing services in this manner was seen to benefit both the client and the individual consultancy. By engaging a service company, the client avoided National Insurance contributions and other employer responsibilities. Typically, the individual also avoided paying NI and enjoyed lower tax rates by taking dividends rather than drawing a salary. It is this tax "flexibility" available to the individual that the new rules seek to curtail.
The good news is that there are still several months before the legislation takes effect. This gives the one-person operation time to review its contracts and take steps to minimise the impact of the new rules. By acting early, you could avoid a hefty tax bill.
Who will the new regulations affect?
Although the new regulations are not yet finalised, we have identified the likely areas for concern. If you answer "yes" to all the following questions in respect of one or more of your contracts or clients, you may be affected by the new regulations:
- Do you provide your services through your own company?
- Do you work for businesses or organisations rather than for private individuals?
- If you did not have a company, would you be considered an employee of your clients if you worked directly for them?
- Do you take dividends or leave profits within the organisation, rather than drawing all the profit from your engagements as salary or benefits?
If one or more of your engagements is affected by the new regulations, the Inland Revenue will deem any associated "profit" from those engagements that has not already been drawn from your company as salary to be salary. PAYE tax and NI would then be due on this salary, regardless of whether or not the profit has been taken as a dividend or left in your company.
- If you take dividends, rather than a salary, you may have to pay more PAYE tax and National Insurance
- You will be liable if the Revenue finds you were acting as an employee of your client
The responsibility for applying these rules will fall on the company – that is, you. Failure to comply with the rules will lead to penalties.
At the crux of these new regulations is the distinction between employment and self-employment. So, the most simple step you can take to avoid being caught by the new rules is to ensure that the basic elements of self-employment apply to you.
It is beyond the scope of this article to cover the distinction between employment and self-employment in detail. However, the Revenue might decide that you were, in fact, an employee of your client, if any of the following statements apply to your engagements:
- Your client would not allow you to send someone else to do the work
- The equipment you use and the place in which you perform the work are provided by your client
- You can neither profit nor suffer financial loss from your management of the work
- Each project you perform for your client is not a separate engagement
- You are part of the client's organisation; for example, you issue instructions to your client's employees
- You act for a small number of clients. It is important to remember that it may not be every engagement that is affected – it is only those in which the Revenue considers that the circumstances of the job would make you an employee if you provided your services direct to the client. It is therefore possible that the proposed rules may only affect part of your company's income.
Geoff Everett is a partner in Smith & Williamson Chartered Accountants. He can be contacted on 0181-446 4371.