Telegraph warns consultants risk being taxed twice on deemed income

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Text of article, by Michael Becket;

CONSULTANTS working through their own 'personal service companies' had better pay themselves soon and pretty handsomely this year or they could be taxed twice on their income.

This is one effect of the Inland Revenue's notorious IR35 rule, which treats people on long-term contracts as employees subject to normal income tax. If their one-man company was paid, say, £100,000 for advice or help, that is deemed by the Revenue to be the individual's income, whether it is drawn from the private company or not. So the first payment on income tax of around £30,000 would be payable by April 19.

Consultants who do not draw the money from their company, choosing instead to save it for the following year, will still have to pay tax this year on the 'deemed' income, and pay again next year on the actual income, warned Bob Dunn of the accountancy firm Stoy Hayward. "The Revenue sees nothing unfair in that," he added.

John Whiting of PwC notes that if the money is taken out in the subsequent year, the way to avoid another layer of tax is to pay a dividend, but a lot of people do not understand that, and it is an unnecessary complication. "I'd like to have that smoothed out" as one of the many improvements to IR35, he said.

Maurice Parry-Wingfield of Deloitte & Touche added that the money would have to be withdrawn by April 5 and within the personal company's financial year to avoid a corporation tax liability as well. To avoid this danger, he has advised people to change their companies' financial year end to April 5.

The problem can be even worse for professionals who have not drawn a salary from their company because they have reinvested the money in developing the business through investing in computers, training and the like.

Only 5pc of the personal company's income is allowable as special business expenses - apart from the normal allowances - explained Mr Parry-Wingfield, so any investment above that cannot be set off against tax. That means any investment over £5,000 for that person would be taxed, even if it was a legitimate commercial investment.

If the individual invests the money all the same, the cash is no longer available to pay the professional - but income tax still has to be paid as if it had been received as salary. Management consultants, engineers and computer experts are usually cited as the main losers under the new rules, but the problem goes much wider.

Mr Whiting has been advising the Association of Temporary & Interim Executive Services on contracts. Interim managers "are a success story and have greatly helped flexibility," but will often get caught by the rules, he said.

According to the Professional Contractors Group, which was formed to fight the tax measure, around 8pc of people acting through personal service companies have given up the fight and gone into full-time employment. Others are going into short-term contracts or taking on non-executive directorships. Mr Whiting warned against magic-bullet solutions: "There is no fiscal garlic you can wave at it - it ain't that easy."

Pamela Edwards of the Professional Contractors' Group said it was ludicrous that the Government was touring the world to persuade expatriate Brits to return, and coaxing foreign computer experts to move to the UK, while at the same time forcing them out of the country through the tax laws. She added that it was even more outrageous to be doing this at a time when other countries are offering tax benefits.

The group said IR35 made a mockery of the Government's claim to be supporting high-tech companies and small businesses. The Revenue has been trying to introduce the measure for many years but previous governments blocked it.

The taxmen say the measure is needed because some people masquerading as individual companies are employees in all but name and that loophole had to be stopped. However, professionals object that the rule is so sweeping that many people who are genuine consultants on long-term contracts get caught.

Mr Whiting also attacked the Government's claim that it was unfair for long-term contractors to pay less tax than employees working alongside them. The contractors "take a lot more business risk than full-time employees," he noted. Moreover, they do not get employment rights and are not included in share or pension schemes, he added.

The Professional Contractors Group has initiated a judicial review on the grounds that IR35 unfairly favours major consultancy businesses that can second their staff to companies without any such tax penalty.

That case is due in the High Court on March 13. It is thought the courts may ask the European Court for a view as well, since part of the group's case covers human rights and right of establishment.