Better Living in IR35’s Shadow

We look at why it may be preferable to cope with the threat of IR35 rather than turn to tax avoidance schemes.

As a new year dawns and the gloomy economic prospects offer little hope of 2012 being a prosperous one, there may be some contractors contemplating increasing their take home pay by using one of the various marketed tax avoidance schemes.

It is easy to see why some freelancers have had their heads turned by the promise of 85% income retention without the Sword of Damocles that is IR35 hanging over them. Those contemplating crossing over into the promised land of milk and honey should be warned that these schemes come with a price and, more often than not, a pretty hefty one.

For several years now there have been a number of schemes around that promise to remunerate contractors with little tax impact and for a material fee, whereas ordinarily such income would be liable to higher or additional rates of 40% or 50% respectively. This has been achieved by various methods such as using offshore bank accounts to draw on 'tax free' income that has been paid via loans or Employee Benefit Trusts.

Virtually all these scheme providers offer promises that their scheme is 100% tax compliant, approved by HMRC and backed up with Tax Counsel opinion, instilling confidence in the unsuspecting contractor that the scheme is kosher and all above board. These schemes are normally too good to be true and the only winners tend to be the scheme providers who, by the time a contractor is subject to a tax enquiry several years down the line, have shut up shop and disappeared, normally because they are based offshore.

Any contractor tempted by the allure of these schemes should consider the following before committing:

  • HMRC do not approve any marketed tax avoidance scheme. Just because HMRC have not got round to raising an enquiry into a scheme is no basis for making bold claims of its authenticity.
  • Every scheme provider must register their scheme with HMRC and, in return, they are allocated a reference number, known as a DOTAS number. This is routine procedure and in no way indicates that HMRC have approved a scheme – far from it.
  • Under self assessment, HMRC ordinarily have 12 months from the date a tax return is filed to make an enquiry into that return. That enquiry window is increased where there has not been a full disclosure. A contractor could have to wait for 3 years before they realised there was a problem with participating in a tax avoidance scheme. For example, a freelancer signs up to a scheme from 6th April 2011 and receives 85% of their income after deductions. They file their 2012 self assessment tax return by the last day of filing, 31st January 2013, leaving HMRC until 31st January 2014 to raise an enquiry. By this time there is potentially 3 years of tax arrears plus interest and most likely a penalty that can be as high as 100% of the tax due. If no provision has been made for such an event, a contractor could stand to lose their property and assets and even face bankruptcy.
  • HMRC regard tax avoidance and evasion as one and the same these days and are supported in their attitude by politicians.
  • By the time HMRC get round to launching their enquiries, many scheme providers have mysteriously vanished leaving the poor contractor to face the music by themselves or incur further costs in securing the services of a competent tax advisor to defend them. Those costs are further compounded if it is necessary for a case to be decided by a Tax Tribunal or the Courts.
  • Will the scheme provider indemnify the freelancer against any tax, interest, penalties and professional representation costs incurred in a resultant enquiry.

Although the uncertainty of IR35 is undesirable and an inconvenience to the contractor's business at least it is something that is more certain than the problems thrown up by the complexities of tax avoidance schemes. From this point of view therefore IR35 is something that can be better managed, anticipated and accounted for. In the event that a freelancer falls foul of IR35 their liability is limited and will not threaten their personal assets.

Those contractors with spouses/partners currently have the ability to own shares jointly in a company and extract up to £42,475 each before tipping into the higher rates, assuming they have no other taxable income. Such remuneration can be taken in the form of a minimum salary thereby not incurring a NIC or tax charge and the majority balance paid as dividend, so long as the company can afford it, and again avoiding a NIC or tax charge.

IR35 may be imperfect but it won't give you the restless nights that an enquiry into a tax avoidance scheme will induce.

2 Comments

  • Aruldoss says:

    Hi Andy,

    This is a nice article. Thank you. I have a question please regarding the below para

    Those contractors with spouses/partners currently have the ability to own shares jointly in a company and extract up to £42,475 each before tipping into the higher rates, assuming they have no other taxable income. Such remuneration can be taken in the form of a minimum salary thereby not incurring a NIC or tax charge and the majority balance paid as dividend, so long as the company can afford it, and again avoiding a NIC or tax charge.

    Are you saying this is illegal or one other alternate option available to the contractors. I could not understand fully this point. If you can shed light on this, great

    Thank you

  • Andy Vessey says:

    Profits extracted by way of minimum salary plus dividends is perfectly legitimate and sensible tax planning. So long as the company can afford to pay the dividends, the shares are ordinary shares and all the necessary paperwork is drawn up each time a dividend is declared then HMRC cannot challenge this arrangement.

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