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How will the Proposed HMRC Tax Changes Affect Recruitment Agencies?

Unless you’ve been burying your head in the sand in the deepest desert, I’m sure that most of you are aware that HMRC have proposed to remove tax relief on Travel and Subsistence (T&S) expenditure with effect from April 2016.

That means that the government is proposing to remove tax relief for ordinary commuting (in general, home-to-work travel and subsistence expenses) for workers who are:

  • Supplying personal services;
  • Engaged through an employment intermediary (including umbrella companies and personal service companies “PSC”s); and
  • Subject to (or to the right of) the supervision, direction or control of any person.

The proposed changes are supposed to make the tax system fairer and create a level playing field for access to tax relief for T&S. Personally I believe the level playing field a nonsense, given the difference in risk and reward  between self-employed contractors and employees. But that’s something for another blog…!

What ever the Government’s intentions, I don’t think it will help either contractors or recruitment agencies. HMRC has stated that it believes that the changes will not have much impact on the temporary labour market. Again, I disagree. I think the changes could definitely pose a disadvantage for recruiters who work with contractors.

So how could this affect recruitment agencies?

  • It will necessitate an additional cost to be paid somewhere in the supply chain to make up for the loss. Are your clients going to wear it? Is the Contractor? Or are you?
  • And,
  • Contractors using a recruitment agency will be disadvantaged in the reduced ability to claim T&S relief versus those directly engaged by clients. Will that turn them off contracting? Will contractors turn down work offered to them by recruitment agencies if they cannot claim T&S relief?

I believe that a client’s ability to recruit temporary and mobile workers could be hampered, which could have a knock on affect for some recruitment agencies. Surely that can’t be right for our economy?

Umbrella, or intermediary companies, have been used to reduce the employer costs involved in employing temporary labour. HMRC is on the verge of making one of the biggest changes to the way agency workers are paid since MSC (Managed Service Company) legislation was first brought in. After the tax legislation is changed in April 2016, umbrella companies may not provide any benefit.

What else is happening? Well, in a double whammy the Government has also announced changes to the rules on how dividends are taxed, with effect from 6 April 2016. These changes are also aimed at PSCs which pay their director(s) a small salary in order to preserve their entitlement to a state pension, coupled with larger dividend payments in order to reduce Income Tax and National Insurance costs. A majority of contractors whom Recruitment Agencies place with clients will be operating through a PSC.

Dividends received by pensions and ISAs will be unaffected. Dividend income is to be treated as the top band of income.

Contractors who are basic rate tax payers and receive less than £5,000 in dividends will need to complete self-assessment tax return form by 6 April 2016.

So, in the face of additional taxation, what options are available to contractors to still make it a favourable way to earn a living? We asked our friendly accountant to make some suggestions:

  • Bring forward dividend payments to the tax year 2015/16:

Any dividends paid before 6 April 2016 will avoid the 7.5% additional tax, and there is no need to pay cash from company – a credit to a director’s loan account can be used. It is important to take care when sorting the documentation, as if the dividends are not paid by 6 April 2016 this must be shown in the accounting books.

In order to avoid incurring the 7.5% additional tax, it is important to avoid moving into a higher tax bracket for 2015/16 and be aware of the tax rate limits. Also look to draw any brought-forward dividends from loan accounts in 2016/17.

  • Transferring shares to family members:

Shares can be transferred to spouses or children, however the children must be over 18. Each person in possession of shares has a £5,000 dividend tax exemption from 6 April 2016, as well as a basic rate band. Different classes of shares can be used, allowing different levels of dividend to be paid to different shareholders and gifts have a wide range of benefits including capital gains and inheritance tax relief, as well as no stamp duty.

  • Charging interest on directors’ credit loan accounts:

Up to £5,000 of interest income is exempt from income tax, only if non-savings income is less that £16,000 for 2016/17. Non-savings income is generally salary/rental income, not dividends. Therefore, if there is a large credit balance on a loan account, it is best to charge interest and keep the salary below £10,000 and take the rest of drawings as dividends. This can be engineered by introducing savings to company, charging interest (tax deductible in company) and paying no personal tax.

  • Considering increasing pension contributions:

The new dividend tax increases the efficiency of paying pension contributions. Tax is deductible for the company (within limits) and there is no tax on pension funds – however, this is not for everyone! Seek independent financial advice prior to implementing any measures.

  • Ensuring that all pension payments are paid through the company:

There is currently no tax difference between the company paying employers’ pension contributions and a director paying personal contributions using dividends drawn from the company. Pension payments have always been a good method of drawing funds from company as tax deductible in company, and there is no tax on the pension fund (there is a lack of access, however).

From 6 April 2016, dividends paid to fund personal contributions will suffer 7.5% tax so do ensure they are paid as employer contributions.

  • Increasing director’s salaries where they are involved in R&D:

If a director’s salary can be treated as related to research and development, then enhanced corporation tax relief is available. This is currently at 130% uplift and covers salary, employers’ NIC and pension.

Dividends are still marginally better than salary in 2016/17, despite the 7.5% tax. This is because of the 13.8% employers’ NIC. However, enhanced corporation tax relief can make the salary option beneficial. Detailed calculations are required to assess the net effect of this.

  • Charging the company more rent for use of home:

It can be worth considering the possibility of replacing part of a dividend with rent for the use of home – however, this is only available if an area of this home is adopted for work use. HMRC generally sets the limit very low – at £4 per week – however this can be increased if there is a substantial amount of home use by apportioning actual costs (including rent/mortgage interest) to the work area. If the loan account interest is being used, rent will restrict that relief as it is non-savings income.

  • Using loans to directors up to £10k:

A company is permitted to lend money to directors interest-free. Income tax is payable on interest – free loans, based on a set interest rate currently at 3%, but only on loans over £10,000 at any time during the year. However, the company has to pay 25% tax on loans outstanding at company year-end if not repaid within 9 months of the year end. This 25% tax is repaid after the loans are repaid.

Loans are permitted to be repaid within the 9 month period to avoid the charge, providing the loan is not advanced again within 30 days.

Anything else?

Other proposed changes include alterations to tax on benefits in kind and corporate tax reduction (from April 2017 19%, from April 2020 18%). This again will affect contractors’ pockets.

I can’t offer you any solutions I’m afraid. It will be a bit of a watching brief to establish the impact on the industry. The only real suggestion is to ensure that you keep your contractors close and happy. Ensure your relationships with them are good and solid. I’m sure the industry will weather the storm, but do make sure your contractors know you are on their side.

If you need any further information on this, or if Cognitive Law can be of any assistance, please do not hesitate to get in touch with Lucy Tarrant on 0333 400 4499 or lucy.tarrant@cognitivelaw.co.uk. Otherwise, thank you for reading this blog.