Income Shifting Legislation

In what many industry figures suggest could be the most significant legislation to hit the IT Contractor market since IR35, the Chancellor announced that he intends to clamp down on the tax advantages currently offered by many composite and managed service companies (MSC's).

In his Pre-budget Report, Gordon Brown said:

"The Government is taking action to tackle Managed Service Company (MSC) schemes which are used to avoid paying employed levels of tax and NICs. Income received by workers in MSCs in relation to services provided through the MSC will be subject to employed levels of tax and NICs, with the MSC obliged to operate Pay As You Earn (PAYE) and deduct tax and Class 1 NICs on that income - and the rules for tax relief for travel expenses will be the same as for other employed workers. The Government will also address the problem of MSCs escaping payment of tax and NICs due by allowing the recovery of these debts from appropriate third parties."

Clearly, many IT Contractors may be affected - so what should they do now?

As with IR35, the Pre-Budget documentation produced to date does not provide 100% clear details on how the Chancellor plans to remove these "tax advantages". How wide-reaching and enforceable these measures eventually become will only be made clear once the new legislation "hits the streets" in April 2007.

So, will contractors currently using composite / managed service / umbrella companies rush to form their own limited companies (subject to the usual IR35 constraints), or will umbrella companies still provide a much-needed service to those who would rather do without running their own operation?

Simon Dolan, from leading contractor accountancy firm SJD Accountancy, recently penned an article entitled "The Death of Composite Companies". In the article, Dolan says:

"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 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".

David Ramsden, Chairman of The Professional Contractors Group, although welcoming changes which promote a fair taxation system, said:

"It is crucial that the scope of this measure is defined to include managed service companies but not freelancers and contractors who are genuinely in business..."

"We would of course not welcome an additional tax burden on the latter group. Our preliminary reading of these proposals suggests that they are sound in this respect."

Ann Redston, Fellow of the Institute of Taxation, told the BBC:

"The government has now announced new legislation that deems all those working within these MSC or composite structures to be employees, so they will have to pay the same NICs and tax as employees."

"However, those who control and manage their own companies have been clearly told that they are not the target: the old IR35 rules will remain in place as before for these personal service companies."

In another article on managed service companies, written by Blake Lapthorn Tarlo Lyons,

"Personal service companies or single member companies operating independently of a managed scheme appear not to be covered by the legislation, and IR35 considerations will continue to apply to these types of companies. The legislation clarifies that the cost of travel between a service provider's home and place at which they work for the service recipient will not be an allowable expense."

Finally, a good read from our friends at Contractor UK - an article which suggests many IT Contractors will look more towards working via limited companies in light of the new proposals;

"...as one contractor put it while reflecting on a mass migration back to running Ltd. companies, "The holiday is over and we have to start saving receipts again, eh! Well thanks for the holiday Gordon."

The Government is inviting consultation on this issue between now and 2 March 2007 - we will update Contract Eye (and our sister-site, Bytestart) with more commentary and opinion during early 2007.