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Her Majesty’s Revenue & Customs (HMRC) are convinced that there is widespread tax avoidance in the construction industry and have recently issued a consultation paper outlining their proposals for tackling the problem – proposals which are likely to result in a substantially higher tax burden for many genuinely self-employed workers as well as more red tape for small businesses which could lead to the collapse of the construction industry.

Way back in the 1970s the then Inland Revenue was similarly convinced that there was widespread tax avoidance in the building / construction industry and so they introduced the Construction Industry Scheme (“CIS” or “the Scheme”). The basis of the Scheme is that anyone receiving payment for work related to building or construction in general must either be registered with HMRC or be paid less a withholding tax which the person or company paying them has to deduct from their payments and then remit this to the tax collectors. All is not lost as anyone not registered under the Scheme can get any overpayment back at some later date, but that does mean they could have a cash-flow problem.

Be that as it may, over the years since its introduction the Scheme has been amended and updated several times, but the important point has always been that the CIS only applied where the person doing the work was self-employed.

Employed or Self-Employed

In general it is true that a self-employed person will pay less tax and National Insurance Contributions (NICs) than an employee. The reasons for that needn’t concern us here but I should point out of course that self-employed persons don’t enjoy the same social security benefits, don’t have the same employment protections, and find it harder to get mortgages or loans at reasonable rates.

The interesting point here is that although deciding whether someone is employed or self-employed is central to their tax position, the whole legal definition of whether someone is employed or self-employed question has never been a tax one. In fact it is the huge volume of non-tax case-law which has provided principles to help determine if there genuinely is a contract of employment and HMRC tend to abide by this case law in most, but not all, individual cases. (For example I had a client who was accepted as being self-employed for tax purposes but as employed for the purposes of the Employment Protection Consolidation Act.)

As things stand for the purposes of the Scheme HMRC publish guidance based on the case law principles in the CIS 349 Guide. Here you will find that factors which may currently be relevant when deciding whether someone is self-employed or not include:

  • The degree of control exercised by the engager (paying entity);
  • The financial risk taken by the worker e.g. are they paid per hour or on the basis of a completed job;
  • Whether the worker has a right to substitute someone else to do the job;
  • The length of the engagement;
  • Whether the worker has other engagements at the same time;
  • Whether the worker got the job through a tendering process;
  • Whether the worker provides their own plant and equipment; and
  • Whether the worker provides the materials needed to complete the job.

If these factors pointed to self-employment then there was previously no question that we were firmly in CIS territory and payment would be made without any PAYE/NIC deductions, either gross, for someone registered under the scheme or net of withholding tax for someone who wasn’t so registered.

That is set to change if the HMRC proposals are implemented.

The New Proposals

The new proposals will classify everyone engaged in building or construction operations to be an employee for tax purposes unless one of three exceptions applies. These are:

  1. Provision of plant and equipment – that a person provides the plant and equipment required for the job they have been engaged to carry out. This will exclude the tools of the trade which it is normal and traditional in the industry for individuals to provide for themselves to do their job;
  2. Provision of all materials – that a person provides all materials required to complete a job; or
  3. Provision of other workers – that a person provides other workers to carry out operations under the contract and is responsible for paying them.

It is HMRC’s view that “these criteria bear the hallmarks of a person genuinely carrying on a business on his own account” without at the same time introducing “unnecessary levels of complexity or uncertainty”.

However, that isn’t to say that all workers who fit into one of the exclusions will in fact be self-employed so anyone paying such a worker will still have to satisfy themselves that the CIS principles still apply and there is no contract of employment. If they don’t apply the rules correctly then the paying entity (contractor or sub-contractor) will be held liable for tax and NIC. This of course will mean that such entities will be ultra-cautious bringing in some genuine self-employed workers into the employment net.

Worse than that it my view is the fact that many workers who do not fit into one of the exclusions may very well genuinely be self-employed on the normal case-law tests. HMRC state that the “purpose of the legislation is not to deem a worker’s income to be employment income where it is clear that the worker is carrying on a business and would otherwise be treated as self-employed.” Yet they must be aware that by excluding the other tests for a contract of employment, they are going to bring many genuinely self-employed workers into the PAYE net. Why make the change otherwise?

In addition the paying entities who currently carry out contracts using self employed workers will now have to take thousands of workers onto payroll with the extra hassle of administration and the extra cost of Employers NIC not to mention the fact that these workers will be entitled to the whole range of employment rights and benefits such as sick pay, holiday pay, redundancy etc etc. That could spell the end of most small building contractors.

Overall the proposed changes would have a number of negative effects. They would:

  • Impose more tax on some genuinely self-employed;
  • Produce an uneven playing field within the industry between the self-employed who continue to be treated as self-employed and those who will be deemed employees;
  • Disproportionately affect smaller businesses;
  • Create an uneven playing field between a class of self-employed in the construction industry and self-employed in other industries, which may encourage workers to move into other areas; and
  • Result in a greater compliance burden for very small businesses and would put the construction industry at a disadvantage compared to other industries where no similar legislation exists.

At the end of the day I do wonder if this will end up like the IR35 debacle, which has cost far more to administer than it has collected in tax.

The construction industry is already in crisis because of the credit crunch. This could kill it off! Let’s pray that the industry lobbyists crush this daft idea.

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