Britain’s tax collection agency is clamping down on umbrella companies used by contractors to pay their dues, with 10,000 outstanding tribunal cases waiting to be heard.
This is according to legal eagles at Pinsent Mason, which says the number of specific instances shot up sevenfold in the 12 months from the 1,200 registered at the end of June 2021.
“With a large number of umbrella companies suspected of VAT avoidance, the tax tribunal backlog has grown massively in a very short time,” Steven Porter, a partner at the law firm said in a statement to The Register.
“Contractors looking to sign up with an umbrella company should be aware that it is likely the umbrella company will be required to pay VAT. HMRC will view any claims to the contrary with suspicion,” he added.
The government’s introduction of IR35 tax reforms in the private sector in April 2021 made businesses that use freelancers responsible for the tax their contractors should pay. In turn, this has resulted in a massive increase in the use of umbrella companies by freelancers, including tech hands-for-hire.
What is IR35?
IR35 is a reform unveiled in 1999 by the UK tax authorities. A regulation change which came into force in April 2021 – meant medium and large businesses in the UK must set the tax status of their contractors and freelancers. Previously this was set by the contractors themselves.
Contractors found to be within the scope of the legislation – i.e. inside IR35 – will have to pay more tax than they might expect.
The reforms are part of the government’s crackdown on so-called disguised employment, where workers behave as employees and are able to slash their tax bills by billing for their services through Personal Service Companies (PSCs), which are taxed at lower corporate rates.
The measures first came into effect in the UK public sector in 2017. The British government hoped the reforms would recoup £440 million (c $486 million) by bringing 20,000 contractors in line.
HMRC reckons that only one in 10 contractors in the private sector who should be paying tax under the current rules are doing so correctly. It estimates the reforms will recoup £1.2 billion (c $1.33 billion) a year by 2023. Both public and private sector reforms had been set to be repealed in September, but the new government quickly U-turned just weeks later, when Jeremy Hunt replaced Kwasi Kwarteng as chancellor of the exchequer. Now both are back on the books.
Using an umbrella company gives contractors the option of having an employer that takes care of tax returns, etc while still having some flexibility to work on a contracted basis.
“HMRC (Her Majesty’s Revenue & Customs) and the tribunal are aiming to clear the backlog of tribunal cases quickly – HMRC are confident that they will win and move on to collecting the VAT it believes it is owed,” said Porter.
“HMRC sees the tax affairs of contractors as an area where it is missing out on a lot of unpaid tax. Umbrella companies are firmly in its crosshairs,” he added.
IR35 has been one of the most emotive subjects for Reg readers in recent years, as they are forced to pay tax like other full-time employees yet do not incur the same benefits such as holiday or sick pay.
It hasn’t helped that despite making the rules, some government departments have not been able to get the reformed rules right themselves, with NHS Digital and Defra among the names being forced to settle bills for unpaid tax just last month.
We have asked HMRC to comment. ®
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