Use of companies by contractors is justified despite witch-hunt by press

Unless you have been deprived of television and internet usage for the past month, you would have been witness to the recent media uprising against the use of limited companies by individuals as a mechanism for providing services, most notably those working in the public sector. Contractors therefore may be wondering if there will be any overspill into the contracting sector in general and what the implications might be in the future.

The “witch hunt” against the use of limited companies within public sector appointment raises some interesting questions. For example, is it right to criticise the relevant department for allowing an appointed representative to operate through a company? The answer to that would be ‘yes’ and ‘no’. Yes, morally if the work being undertaken would normally be the responsibility of an employee and the use of a company disguises what is effectively an employment relationship. No, from the point of view that Parliament has not prohibited the use of a company as an operational vehicle by individuals, indeed tax law specifically contemplates the use of companies where there is disguised employment (i.e. IR35), and use of a company by Mr. Lester, the first of the “accused”, has saved the department money.

It is worth reminding those that criticise the use of companies in these circumstances that where there is disguised employment the tax breaks normally allowable to a company are not permitted and tax must be paid on a quasi employment basis under IR35. Thus in the case of Ed Lester, for example, since he seems to have worked in an employment way, he and the Student Loans Company legally are beyond reproach provided he ticked the box on his company’s tax return to say that IR35 applies, and the right levels of tax have been paid.

Others, such as Moira Stewart, appear to have been engaged on projects and may not therefore be paying tax under IR35. It is difficult to see why, with this case as an example, government departments should be criticised for hiring in outside contractors – after all if all government contractors were paid as employees the cost consequence would be considerable for all of us!

The bigger question though is why tax breaks for companies exist in the first place. Firstly companies are different legal entities from individuals. But, as with self employment, the original idea was that those engaged in business should be entitled to additional reliefs to allow them to grow their businesses, to create employment, and to reflect risk. The problem that the press appears to sense is that so far as some personal service companies are concerned the reason for the breaks is missing. The companies exist but not the business plans or the risk. Accordingly the thinking is that the breaks should not be due at all.

Indeed it cannot be right, so the argument goes, that tax breaks can be due just because an individual, who otherwise would be subject to full PAYE and NI, has paid £25 to buy a company off the shelf. Add to that the fact that employers using limited company contractors also avoid paying employers NI and we begin to see the background for the witch hunt. We are in an economic crisis, everyone should be contributing. Not only are individuals avoiding tax that the rest of us have to pay, but supposedly responsible government departments are facilitating it and saving payment of NI to boot. Hypocrisy of the highest order!

Critics of the witch hunt would say that it the use of companies is entirely legal, as indeed it is. This means that it is sanctioned by Parliament. But is the current tax regime equipped to collect “fair” levels of tax from contractors in the circumstances of “disguised employment”? Putting aside the many valid arguments that IR35 should be tidied up, these tax rules sought to address the issue but in doing so still allowed for a lower tax take for HMRC. Those that operate through a company in a disguised employment way, or putting it another way, without having a genuine business proposition, still get some tax breaks because they operate through a company, and the press does not appear to understand the rationale. The press therefore smells blood given the need for all citizens to pay fair and equal levels of tax in the current climate.

One thing is certain, the use of limited companies has caught the public’s attention, and with the coalition government eager to win back the hearts and minds of the public where austerity measures are biting, this could lead to swift and drastic change to appease their concerns. With the Budget due in March, this may prove a tempting opportunity for George Osborne to reform IR35 rules to crank up tax receipts in the name of public interest.

Whatever the outcome, it seems plain that the public will not tolerate situations whereby individuals such as Ed Lester occupy high level government positions, whilst gaining tax advantages via the medium of a limited company. Morality rules the day on that one and no doubt a new government code is already in place. But so far as other non “disguised employment” engagements are concerned it is difficult to see any basis for changing the rules in principle, leaving those engaged in business, facing risk and opportunity, with the best fiscal support to grow. A more transparent delineation of the tax rules in this area would serve everyone well.

Adrian Marlowe

Managing Director

Lawspeed