The UK Chancellor of the Exchequer is threatening to issue a major tax blow to freelance contractors in next week’s Budget. This will in turn restrict the mobility of labour and could lead to a serious shortage of skilled experts, particularly in the IT and engineering markets, according to Barry Roback.
Roback, Chief Executive of the JSA Group, points out that many contractors, who the Revenue accept are genuinely self-employed, acquire limited company status to benefit from the tax and NI advantages that are currently available, particularly after the 2002 Budget when the starting rate of Corporation Tax was reduced to nil.
Some thought at the time that the Treasury had not really intended to offer this tax advantage to the one-man business, but the Inland Revenue insisted that this policy was deliberate and designed to encourage an entrepreneurial spirit.
However, it has now indicated that it is on the warpath for those who may have escaped its notorious IR35 net. This effectively taxes independent contractors at the same rate as those on PAYE, where the work that they undertake is under the daily direction and control of their clients.
‘It would appear’, says Roback, ‘that two years later, the Treasury has changed its mind. The current threat comes from Paragraph 5.91 of the 2003 Pre-Budget Report which warns that the Government will bring forward specific proposals for action in Budget 2004 to ensure that the ‘right amount’ of tax is paid by owner managers of small incorporated businesses’.
This threatened change coincides with the Chancellor’s recent announcement of an ambitious investment plan to bolster the UK’s engineering and science performance.
‘In a typical example of disjointed Government thinking,’ he adds, ‘the result of these impending tax changes will be that fewer specialists will be tempted into the world of freelance contracting, leading to a less fluid labour market and economic stagnation. Ironically, the Revenue is proposing to introduce these changes at a time when there has been a noticeable increase in demand for independent contractors after a lengthy recession in that sector.’
According to Roback, many organisations now realise they cannot put off investment in technology any longer and are looking urgently for specialists at all levels. He points out that the UK has the most mobile and least restrictive skilled labour market in Europe, which over the years has attracted considerable overseas investment.
‘However, it would seem that the Treasury is in danger of losing this advantage by increasing the tax and bureaucratic burden on those who are prepared to take the risk of self-employment,’ maintains Roback. ‘Although the Chancellor insists on keeping us guessing, his likely intention is that dividends derived from the typical one-man personal service company will be subject to some kind of investment income surcharge or perhaps National Insurance, in much the same way as a PAYE salary.’
‘Not only will this have a material effect on a freelance contractor’s overall reward package, it may also trap them in a potential taxation double whammy. In addition to a Corporation Tax bill for last years’ profits, this year they must also fund the additional tax and/or NI that will become due under a new regime.’
Barry Roback stresses that of all professional groups, knowledge-based contractors, particularly within the IT and engineering sectors, have probably been hit hardest by the Government’s revolving door approach to tax.
‘They first attracted the attention of the Revenue during the dot.com boom when reputedly many left their PAYE jobs on a Friday, only to return the following Monday as self-employed contractors, reputedly doing virtually the same job as before. In reality, this seldom if ever was the case, but it did reflect the entrepreneurial spirit of the time. Not surprisingly, the Revenue found the Klondike atmosphere that prevailed distasteful and felt the need to step up their interest in the self-employed.
‘Although Downing Street and its DTI allies appear keen to promote entrepreneurial get-up-and-go UK plc, the Treasury seems determined to snuff out any flicker of enterprise.’
Roback concludes: ‘Freelance contractors have a vital role to play in our service-driven, highly mobile economy. They deserve to be treated with respect by the Chancellor and given more consistent tax treatment. They are the geese that have laid the golden eggs for the Treasury and they need to be nurtured not neutered by thoughtless and disjointed thinking by the Inland Revenue. Many threatened to leave for jobs abroad after the introduction of IR35, but after this Budget, those threats may well become reality unless the Chancellor decides to give these vital contributors to UK’s recent economic success a fair deal and leave the tax rules on limited companies alone.’