Contract workers versus the taxman: a draw is on the cards

A controversial new government tax crackdown looks likely to be watered down.

The Government has put forward moves to water down a controversial tax crackdown on contract workers. The original proposals, which were targeted mainly at senior executives who endeavour to dodge tax by working for their own service companies, would also end up hitting contract workers whose clients exercised the smallest degree of control over their work. It is this "control test" which has prompted much if the wave of protest provoked by the Government's plans.

The Government suggested changes to tighten the scope of new legislation at a confidential meeting with tax experts that took place earlier this month One tax expert whose organisation was represented at the meeting observes: "They - the Government - are thinking of changing the control test, and quite rightly so. They have realised that the control test just isn't going to be workable, so therefore they are looking to change the test."

The control test as it stands states that new tax rules would apply to any contract worker "where the client has a right of supervision, direction or control as to the tasks undertaken or the manner in which they are performed".

Small business representatives have, however, argued that it is hard to imagine any case where this wide a test would not apply. Any contract worker caught by the new rules would have to obtain a special Inland Revenue certificate before his company could accept payments without prior deduction of tax (see story below right).

One suggestion made at the recent meeting was that the new legislation should instead make a similar distinction as the schedule D (self-employed) and schedule E (employee) tax codes. Contract workers whose routine made them look more like employees would be caught by the new rules, but others would not.

However, Simon Sweetman, of the Federation of Small Businesses, believes that this would prove a difficult line to draw for knowledge-based workers, such as software engineers. Computer consultants are one of the key groups who insist that they will find themselves being unfairly targeted by the Government's latest moves.

Sweetman says: "If you get a self-employed software consultant in, he's paid an hourly rate. He's working on machines that belong to the client. Anything he produces in terms of software, the copyright probably belongs to the client. On the traditional view, all those things look rather like employment, and that would remain a problem."

Richard Baron of the Institute of Directors will say nothing about what took place at the meeting between the tax experts and the Government, but agrees that any schedule D/schedule E style divide would be a partial solution at best. "I think it would be a sensible move," he says. "But I don't think that it would be a complete answer."

The Inland Revenue will not comment on what was said at last week's meeting. A Revenue spokeswoman said: "There have been no final decisions taken yet at all. Ministers have not made up their minds, and there has been no discussion further to the meetings with the representative bodies."

An announcement on the Government's amended proposals is expected soon.

What The Proposals Mean

MANY EXECUTIVES find they can save tax by setting up their own service companies while continuing to work for their old employer as a consultant.

This allows the worker involved to pay himself via dividends rather than a salary, so escaping the PAYE system, as well as eliminating national insurance payments for employer and employee alike. This avoidance costs the taxman about pounds 300m of lost revenue in a full year.

The Government is proposing that all contract workers be forced to obtain an Inland Revenue certificate before they could take payments gross of tax. Getting a certificate would mean agreeing to pay yourself a salary via the PAYE system and accepting liability for both employer's and employee's NI payments.

Anyone without one of the new certificates would be given their pay after deduction of both income tax and NI - in other words, they would be treated exactly as if they were an employee. Either way, the opportunity for avoiding tax disappears.

If the only people this looked like hitting were hardened tax cheats, then few people would object. But the Government has cast its net far wider than just that group.

Groups representing small business owners protest that the proposals as they stand would also hit many innocent contract workers who have no intention of avoiding tax. Computer consultants, for example, often work via their own service companies because the clients using them will not take on anyone requiring an employer's NI contribution.

The new contract worker rules - in whatever shape they finally emerge - are due to take effect in April next year.