Umbrella company expenses – Are you really compliant?

With HMRC's spotlight still fixed on umbrella companies and particularly their compliancy with current rules, UKTECH has recently carried several views from experts as to what umbrella companies - and the contractors who operate through them - should be looking at.

John Hill, Director of Employment Taxes at BTG Tax, shares his views and experiences.

John Hill writes:

In his article (HMRC to target umbrellas? ..and agencies? - Dec 2008), Bob Jones emphasises the compliance issues that umbrella companies are likely to face in the light of the Chancellor's PBR statement that the existing expense rules would be more rigorously policed. My own experience is that there are many umbrella companies out there that wish to be compliant, or believe that they are compliant, whereas the reality can be quite different.

Use of over-arching contracts

The first condition to be satisfied, before looking in detail at the expenses that could be claimed, is whether or not the employment contract itself is an over-arching contract. This is often overlooked by umbrella organisations who assume they can pay tax free expenses simply because they hold a P11D dispensation.

The issue is paramount as, without an over-arching contract, employees will be treated as engaged on a series of individual employments and travel expenses within those employments will be taxable.

Local HMRC offices, under the guidance of Head Office are already asking umbrella companies to prove that their employees are engaged under an over-arching contract by demonstrating that there is an ongoing relationship between themselves and the employees between assignments. In particular, they are requesting evidence to show that the umbrella company has a continuing obligation to the employees, including the making of payments to employees, during these periods.

The practical difficulty here is that we are dealing with what is largely an employment law issue rather than an employment tax one, and, although there have been employment law cases relating to the use of an over-arching contract, they do not necessarily rest on all fours with an umbrella type organisation. HMRC's view of what does, or does not, constitute an over-arching contract, may only be fully tested by a case being taken before the courts.

Even where an organisation can satisfy HMRC that their employees are engaged under over-arching contracts of employment, there are still many practical areas where an organisation can get it wrong and companies can expect future PAYE inspections to include the following checks, viz:

Definition of temporary workplace

The general rule, well known, is that a journey is not a business journey if it is to a permanent place of work and therefore only travel to a temporary place of work is allowable. However, this rule is frequently misinterpreted, leading to potentially significant PAYE/NIC arrears.

24 months' rule

The rules state that a Temporary Workplace is a location where the employee is required to carry out "a task only of limited duration or for some other temporary purpose." For the purpose of operating this rule, HMRC regard a period of up to 24 months as being temporary. The test is whether the employee has spent or is likely to spend more than 40 per cent of his or her working time at that place over a period of more than 24 months. However, this is not the only rule.

Single assignment

The first test is whether the employee is carrying out a task of limited duration or temporary purpose. Where an employee attends a workplace for all or almost all of the period for which he or she holds, or is likely to hold the employment it is not treated as a temporary workplace. So, if an umbrella company takes on an employee for one assignment, and then the employee leaves, all the travel costs of that assignment will be taxable regardless of how short the engagement is.

HMRC guidance also states that an employee attends a permanent workplace if the attendance is frequent or follows a pattern. Although the proportion of an employee's working time spent at a particular location is a factor (ie the 40 per cent rule) it is not the only factor and Revenue guidance also goes on to say that if the employee attends the workplace on only one or two days a week, if it is on a regular basis, the workplace may still be a permanent workplace.

For example, if an employee normally works in Manchester but it is part of his normal pattern of duties to work in London every Friday, then London could be regarded as a permanent workplace and no travel expenses will be allowed.

Changes in Workplace

New employee

There are some providers who take the view that the 24 months' clock starts again when a contractor first joins them as an employee. Although there may be a technical argument as to whether the legislation refers to "an employment" or to "the employment", it is HMRC's stated view that the clock does not start again otherwise the system is wide open to abuse. If a contractor has worked on a site for two years before joining a new umbrella organisation, no travel expenses will be available for continued travel to that site.

Cost of new journey

Umbrella organisations must also ensure that their procedures are robust enough to identify when a change in work location is, or is not, a new workplace for tax purposes.

The basic principle is that the new location must have a significant effect on:

• the new journey the employee has to make, and
  
• in particular, the cost of the journey.

Some employers fail to look critically at the cost of the new journey and if that is not significantly different, there is no tax relief for travel to the new location.

Journeys to be compared

There can also be a misunderstanding of the journey that has to be taken into account. For example, where an employee lives in Liverpool but is taken on to work in Glasgow, there can be no relief for expenses in travelling up to Glasgow or for accommodation there. Generally most employers will get that right. But what if the employee is then sent to work in Paisley, 25 miles away from Glasgow for a 6 month task? Although he/she now has an extra journey (and cost) from the accommodation in Glasgow to Paisley, HMRC say that the whole journey has to be taken into account (in other words, the journey starting and finishing in Liverpool) and as that is not significantly different, Paisley is probably not a new workplace and any travel expenses paid will be taxable.

Record keeping

In order to satisfy HMRC officers, umbrella companies will need to ensure that their records and procedures are sufficient and robust enough to show that they are dealing correctly with the following issues:

• whether the employee is engaged under an over-arching contract
  
• whether procedures are in place, and records available, to ensure that the employee is not going to work at one location only
  
• whether processes are available to check where the employee was previously working
  
• whether checks are made to ensure that attendance at a site is not regarded as frequent or follows a pattern
  
• whether procedures are in place to monitor the change in journey and cost of that journey where a new location is notified
  
• whether procedures are in place to pay over the PAYE and NIC on tax free travel expenses if an employee leaves after only one assignment.

These checks will be in addition to the usual checks to ensure:

• that any scale rate allowances do not include a profit element (even if previously agreed by HMRC under a dispensation) and
  
• that expense claims are properly completed, authorised and vouched.

PAYE/NIC liability

Where an umbrella organisation has not followed the correct procedures, the PAYE/NIC arrears will rest with that company and not with individual employees. HMRC have confirmed that they intend to recover tax, interest and penalties over at least a six year period if mistakes have been made. As an umbrella organisation is unlikely to have funds available to meet the liability, this is likely to result in the demise of that company.

John Hill

Director of Employment Taxes

BTG Tax john.hill@btg-tax.com

0161 837 1877