The taxman is to crackdown on staff employees who set themselves up as 'companies' to avoid paying income tax, the Chancellor has pledged.
Tax-efficient: Fiona BruceIt follows recent revelations about public servants who have exploited a loophole that enables them to pay corporation tax - of 20 per cent - on their 'revenue' rather than income tax of 40 per cent or 50 per cent.
It emerged earlier this year that the head of the Student Loans Company, Ed Lester, had saved an estimated £40,000 a year from his tax bill.
Mr Lester, who earns £140,000 a year, has been paid through a private firm under a two year contract signed in January 2011.
Ken Livingstone, London mayoral candidate, is also paid through a company.
These 'personal service companies' are also popular with top-flight footballers, celebrities - including a handful of BBC presenters - and among highly paid workers in the City.
The letter of tax law, under a heavily contested regulation called IR35, already states that employees cannot resign and start work again in their old job employed as a company, known among contractors as 'doing a Friday to Monday'.
But the benefits of switching over to the system of payment has enticed hundreds of thousands of people to set up personal service companies where national insurance - normally 12 per cent on basic earnings - is also avoided.
Typically, those with PSCs can pay themselves dividends of around £35,000 a year without incurring further tax (they will have already paid 20 per cent corporation tax). They then wind-up the company after a few years to release the cash and start the process again.
Tax chase: The Government has pledged to enforce rules on 'personal service companies'
More... How YOU can use this loophole to cut your tax rate to 20%
The rules state that ‘if the relationship between the worker and the client would have been one of employment had it not been for an intermediary the worker pays broadly tax and National Insurance Contributions (NICs) on a basis which is fair in relation to what an employee of the client would pay'.
THE RAPID RISE OF ONE-MAN COMPANIESThe number of UK freelancers now totals 1.56 million, up from 1.4 million in 2008.
The Professional Contractors Group, which offers legal advice to such workers, estimates that around 600,000 of these are 'one-man limited companies'.
It has been especially popular in the City where sky-high salaries encourage workers to seek tax avoidance measures.
Many high-profile BBC stars, such as presenter and newsreader Fiona Bruce, set themselves up as companies ahead of the introduction of the 50p tax rate in 2010.
It is also popular among top-flight footballers and other well-paid sportsmen.
But it has remained a grey area with many of these one-man 'companies' working for one employer on a 9 to 5 basis.
Buried in the Budget papers, the Chancellor has now promised a crackdown.
He stated: 'The Government will introduce a package of measures to tackle avoidance through the use of personal service companies and to make the IR35 legislation easier to understand for those who are genuinely in business.'
He said this would include:
strengthening up specialist compliance teams to tackle avoidance of employment income;simplifying the way IR35 is administered;and subject to consultation, requiring 'office holders/controlling persons who are integral to the running of an organisation' to pay income tax and national insurance at source.The Professional Contractors Group (PCG), which offers legal advice to freelancers, has successfully fought the HM Revenue & Customs (HMRC) on the legislation.
The latest figures it has published, up to March 2010, claim that PCG legal advisers had won 1,485 cases for members while HMRC won just eight.
'MY £99,000 TAX BILL'In one of the few victories for the taxman, an IT contractor for the AA was forced to pay £99,000 in back-dated taxes by a tribunal in 2007 after he was said to have become 'integrated' while working for the car breakdown group between 2000 and 2003.
Revenue & Customs figures released under the Freedom of Information act show how the taxman has drastically scaled back IR35 challenges, with more than 1,000 'enforcements' of the legislation in 2003 falling to just 23 last year.
A 'forum' was created last year by the Government, which includes HMRC and PCG representatives, to improve clarity on how the rules are applied.
The PCG is now seeking 'urgent clarification' over the 'significant announcement' that those integral to the running of an organisation have to pay PAYE tax.
John Brazier, managing director, said: 'These plans appear ambiguous and may affect senior interims and it is crucial that these legitimate businesses do not suffer as a consequence.
'PCG will work hard to ensure that interims, consultants and contractors are well represented in this and their case heard to protect the need for a flexible workforce in the UK.'
He added: 'PCG has worked hard on the Government’s IR35 Forum in the last year and had been hoping there would be more of an update in the Budget than this rather generic statement.'
THE CIVIL SERVANT BOSS EMPLOYED AS A 'COMPANY'The head of the Student Loans Company, Ed Lester, walked into a storm of controversy when it was revealed that he had set himself up as company to be paid.
Tax tricks: Ed Lester, SLC chief executive, who paid his £140,000 salary to his 'company'
He was forced to pay tax and National Insurance contributions from his pay packet in future by red-faced ministers, but kept the tax savings from before that.
It saved him an estimated £40,000 a year from his tax bill.
Mr Lester, who earns £140,000 a year, was paid through a private firm under a two year contract signed in January 2011.
Chief Secretary to the Treasury Danny Alexander, who signs off civil service salaries above £142,500, said he was 'not aware... of any tax benefit to the individual concerned' when approving the salary level.
In light of Mr Lester’s case, he asked the Treasury to review the 'appropriateness of allowing public sector appointees to be paid through this mechanism'.
'I have also asked the Treasury officer of accounts to write to all accounting officers across Whitehall to remind them that all appointments should, in line with existing guidance, consider the wider cost of lost revenue to the Exchequer when considering value for money.'
How he did itMr Lester was appointed interim chief executive in May 2010, following months of chaos at the SLC. He was then paid through the recruitment firm Penna plc which placed him with the Student Loans Company.
The £900 daily fee for his work went to a private company he owns - rather than to him personally. It means he has been able to pay corporation tax of 21 per cent (since cut to 20 per cent for the smallest businesses) instead of income tax of up to 50 per cent.
In addition, Mr Lester, a former chief executive of NHS Direct, received £550 a week to cover expenses involved in travelling from his home in Buckinghamshire to the SLC’s offices in Glasgow.
In January 2011, he was appointed on a two-year contract but retained the terms of his temporary employment, instead of being added to the payroll.
So far, there's no indication that ministers will force him to repay the tax he avoided, although he could still face a Revenue IR35 enforcement to repay. It only made 23 such orders last year.
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