As we found out at Osborne’s Autumn Statement on 25th November, the government are pushing forward with their proposals to restrict tax relief on travel and subsistence for workers engaged through an employment intermediary; the definition of which encompasses umbrella companies, recruitment agencies and personal service companies (PSC). Whilst this announcement was little more than a footnote in the Autumn Statement (a single paragraph of a mere three sentences, in fact!), fast-forward a couple of weeks and we now have a lot more “meat on the bone” due to the publication of two additional documents; the “summary of responses” to the initial consultation that was launched earlier this year, and the “policy paper” which outlines the basic structure of the revisions and also details HMRC’s opinion on their socio-economic impact. Both documents can be found below our blog should you wish to read them.
Liberty Bishop has been heavily involved in the consultation process and has already published commentary on its progress over the last few months, but seeing as we now have a much clearer picture of the finer details, it’s worth revisiting the topic again; not only to provide a more detailed summary of the changes that are coming into force, but to also offer some analysis and opinion as to how they might play-out in the “real world”. So let’s make a start with that summary.
(NB: the policy document is in draft form and has potential once again for adjustments before the final stamp of assent, a date which will be nearing the budget 2016).
As of the new tax year (6th April 2016), new restrictions will apply to the application of tax relief on travel and subsistence (T&S) expenses when the worker in question is engaged via an employment intermediary. The restrictions essentially revolve around the issue of employment status and basically state that if an individual’s working practices indicate that they are more like an employed-type worker, then access to tax relief on travel and subsistence will be denied.
But this is where it gets a bit more complicated, because there is not a singular test that is to be used in order to determine whether or not a worker is an employed-type worker. Instead there’s actually TWO DIFFERENT TESTS:
• One designed for umbrella company workers that uses the yardstick of “supervision, direction, and control” (SDC) to determine whether a worker can gain travel and subsistence relief
• A separate test (the intermediaries legislation – IR35) to determine whether a worker engaged via a PSC gets access to travel and subsistence relief
This two-test approach was not HMRC’s initial intention and did not appear in the original consultation document. We learn from the “summary of responses” document that this was a relatively late revision – following on from stakeholder feedback during the consultation process – and was introduced to acknowledge that it would be “overly complicated and burdensome” (3.21, p.10) for PSC’s to have to consider two different tests for each assignment; an SDC test to determine their eligibility for travel and subsistence relief, and the IR35 test to determine remuneration via dividends.
This two-test approach does raise some interesting questions and observations, which we’ll come to shortly in our analysis and opinion overview…but we first need to discuss another late revision that did not appear in the original consultation document; the decision to implement a particular debt transfer structure that only arose out of discussions during the consultation process itself; at the roundtable events that Liberty Bishop were involved in.
As you may recall, the original consultation proposal offered-up two debt transfer options, and essentially asked stakeholders to pick which one they thought would work best. The first option proposed that the debt liability would be held jointly and severally between the employment intermediary and the engager. The second option, however, proposed that the liability would only sit with the employment intermediary, unless the employment intermediary had been misled in such a way that it caused it to generate a travel and subsistence tax debt. In this scenario the debt could be transferred.
What we are now presented with, however, is a “third option” of debt transfer whereby we have a two-pronged approach that will see either:
• The debt transferred jointly and severally from the employment intermediary to its own director(s) in instances where there has been a conscious misapplication of the rules by the employment intermediary and the guidance of the engager had been ignored.
• The debt transferred from the employment intermediary to another party (e.g. the engager) in instances where it can be shown that the employment intermediary has been misled by that party into believing travel and subsistence relief was allowable when in fact it was not.
The argument made in favour of this more sophisticated model of debt transfer, thus being able to effectively penalise the engagers that would mislead an employment intermediary, or Directors of the employment intermediary as this will hinder those that deliberately disregard the rules that have historically been known to have otherwise liquidated their employment intermediary and avoid any personal liability.
So what can we say about this new travel and subsistence framework from a “real-world” perspective? Does the tax theory work in practice, and what impact is it likely to have on UK contracting?
We can frame this discussion in the context of a possibility that HMRC itself openly acknowledges (in its policy paper); that these changes may result in a decrease in the use of umbrella companies and a corresponding increase in the use of other types of employment intermediaries. Now HMRC doesn’t specifically reference PSC’s as the other employment intermediary, but bearing in mind what the definition of an employment intermediary covers, and considering the other recent legislation that has been introduced to restrict the use of offshore intermediaries and engaging via sole trader status, it’s hard to envisage that HMRC has in mind anything other than PSC’s when it refers to this potential increase.
We would have to agree that there is likely to be a migration away from the use of umbrella companies towards Limited company incorporation. These legislation changes assume that SDC applies when working through an umbrella company, so the onus is on the engager to demonstrate that this is not the case. Since it is notoriously difficult to prove a negative – a lack of supervision, direction, and control – it is likely that the umbrella model will become a less tax efficient option for the vast majority of current umbrella company employees. Whilst HMRC would obviously argue that this reduction in tax efficiency is justified, from the workers’ perspective they are now out of pocket and it’s hard to imagine that they won’t be looking for other ways of recovering these losses.
All of this is further compounded by the fact that last-minute revisions to the Finance Bill 2015 (now enacted into law) will shortly prevent contractors and freelancers using umbrella companies from claiming tax relief on any expenses on an ongoing basis via the umbrella PAYE process. Instead, expenses incurred during the course of umbrella company employment will need to be offset via the end-of-year self-assessment method. These changes are detailed sub-section 5b of Section 289A of the March 2015 Finance Act.
It appears, then, that the interaction between these two aspects of tax law will essentially mean that the issue of SDC will only determine whether or not an umbrella worker can claim T&S tax relief at the end of the tax year through self-assessment, since there is no possibility of any expenses relief being given on an ongoing basis via the umbrella PAYE mechanism.
Lord Palmer has recently discussed this amendment to the 2015 Finance Act in the House of Lords, pointing out that not only does delaying the receipt of tax relief in this way penalise umbrella workers, but forcing all umbrella workers to claim via the self-assessment route also increases the likelihood that they’ll need to employ the services of an accountant to ensure their affairs are in order, which of course will come at additional cost on top of the fees they’re already paying to the umbrella company for processing their payments. Given this set of circumstances, would it be surprising if the appeal of the umbrella model was drastically diminished come April 2016?
It’s also worth mentioning that the interaction between these two aspects of tax law also appears to cause potential problems for the particular transfer of debt model that HMRC has chosen to adopt in order to police T&S claims. If the umbrella company is not able to offset any of its employees expenses under PAYE as part of the umbrella company service, then how can the umbrella company (as the employment intermediary), it’s director(s), or the engagers ever be reasonably held accountable should a worker incorrectly decide to offset T&S expenses at the end of the tax year via a self-assessment that neither his engagers nor his umbrella company employer have any awareness of, or control over?
So that pretty much covers the main questions and concerns hanging over the umbrella company option post-April 2016…but what can we say about the other employment intermediary option that we think will step in to cater for many of those 400,000 + umbrella workers that may be looking for an alternative?
Clearly the most important point to cover with respect to PSC’s is the (unintended) consequences that result from IR35 being used as the test for travel and subsistence relief instead of the SDC test that’ll be used with regards to umbrella workers. There are a couple of things to say about this; firstly, given that they are two distinct tests, is it possible that discrepancies will arise in access to the same tax benefit, for workers carrying out the same role, simply because they use different types of employment intermediary and therefore “sit” different tests? And secondly, could such a possibility lead to any commercial advantage for PSC’s?
It’s difficult to answer this first question at such an early stage, when the changes have not yet come into force and we therefore have no practical experience of how they’ll be interpreted “on the ground”, but it’s seems fair to comment that since an engager will only get involved in the process when they’re determining SDC in relation to an umbrella employee, and not when a PSC is considering IR35, the simple fact of the disparity in engager involvement itself may have an impact on outcomes.
We’re reminded of the old saying “two heads are better than one”, and it seems reasonable to speculate that an engager and an umbrella worker (when putting their heads together over the issue of SDC on the role in question) will have a better chance of getting the right result than when a PSC’s director is left to his own devises to consider IR35 in relation to the role without the engagers input. Our suspicion is that in this scenario, we will see PSC’s tending to find themselves outside of IR35 far more often than umbrella workers are found to be lacking SDC, even when the role in question is one and the same.
By PSC’s getting the “wrong result” more frequently, this means, of course, that they are actually at a tax (and therefore commercial) advantage by offsetting travel and subsistence relief incorrectly. It’s true that this tax advantage is actually a tax debt to be transferred to the director personally should this relief result from a deliberate misapplication of the rules, but what if it’s an honest mistake made primarily due to the lack of engager input when determining IR35 status? And even if it was a deliberate misapplication, this merely puts us in the same position that we’re already in with regards to IR35 and dividend payments; that IR35 is often abused but that PSC’s are willing to run this associated risks because HMRC are under-resourced and cannot catch everyone.
This brings us nicely onto our final point that we wish to raise; that so much of the success of these legislation changes will be dependent upon what the government chooses to do with any future revisions of IR35. As things currently stand, these changes around employment intermediaries and travel and subsistence clearly seem to favour increased volumes of Limited company incorporation, but this would not necessarily be a long-term trend should revisions be made to IR35 which have the effect of stemming the flow away from umbrella companies.
Only time will tell what happens in this area, but rest assured Liberty Bishop will be involved in the consultation process and will keep you updated as things develop.
Please feel free to get in touch with any questions.
Draft Legislation, Explanatory Note and Guidance
Summary of Responses