Income Shifting Legislation

Article penned by Simon Dolan - SJD Accountancy.

The recent pre-budget report by the Chancellor of the Exchequer, Gordon Brown, has sounded the death knell for Composite or Managed Service Companies (MSC). In his speech to Parliament he said, "The Government is taking action to tackle Managed Service Company schemes, which are used to avoid paying employed levels of tax and NICs", adding that contractors providing services through an MSC will, "Be subject to employed levels of tax and NICs".

There are, according to the Revenue over 200,000 individuals working through Composite Companies in the UK, most of which are operated by dedicated service providers. In essence, a Composite Company is an artificial entity that, to date, has enabled a number of contractors to benefit from reduced tax liabilities by making use of dividend payments through a contrived and multi-tiered share ownership structure.

We have always advised against the use of Composite Companies, as we have recognised for some time that their contrived nature make them a prime target for the Inland Revenue. As predicted, these new proposals will dramatically change the environment in which contractors can operate and those who choose to work through Composite Companies will now have to pay tax as if they were directly employed; although the legislation has still to be finalised it will take effect from 6th April 2007.

Contractors that are currently using a Composite Company therefore need to take immediate action if they are to avoid a potentially sizeable tax bill. In essence, the choice for each contractor is between using an Umbrella Company or forming their own Limited Company.

Unscrupulous Umbrella Companies have also been hit by this legislation. Buried deep in the 72 page document outlining the new proposals is a paragraph which states that the ability to claim high levels of expenses through umbrella Companies are to be stopped. Genuine and ethical Umbrella Companies are a convenient way of minimising paperwork for individual contractors, and provide a very useful mechanism for lower paid or short term contractors. In recent years however there have been several Companies set up with the express intention of urging Contractors to make often false expenses claims to bolster their earnings.

Working through an Umbrella Company still requires each contractor to pay tax and National Insurance in the same way as ordinary employees. As a result, net earnings will typically be in the region of 60 to 65% of a contract value and contractors moving from a Composite Company arrangement to an Umbrella Company will find themselves paying the full PAYE and NI amount almost immediately.

By comparison, although a Limited Company involves a little more paperwork, it can enable you to take home up to 83% of your contract value and, despite what many operators of Composite and Umbrella Companies may claim, is actually simple to set up and operate. In addition, Limited Companies can be administered by qualified accountants at modest cost; indeed, accountants such as SJD Accountancy offer fixed fee changing backed by service guarantees.

The recent change signalled by Gordon Brown means that contractors operating under Managed Service or Composite Companies urgently need to review their situation if they are to minimise their future tax liabilities. There are other and arguably more cost and tax efficient options, and advice is freely available from companies such as SJD Accountancy to help maximise earnings legally and efficiently.

See also - Managed Service Company Proposals - Legal Analysis, and The Government's take on Managed Service Companies.