Contractor rates to be hit by tax changes?

Rates for IT contractors could be forced up by new Treasury taxation changes due to come into force in April, recruitment bodies and accountants have warned.

The Treasury is aiming to tackle what it calls "disguised employment" by contractors who use a managed service company (MSC) to avoid paying the level of national insurance contributions (NICs) and PAYE that those in full employment would.

MSCs are intermediary companies through which the services of a contractor are provided to a client and the contractor is paid in a mixture of wages and dividends. The proposed new legislation would require contractors in MSCs to pay national insurance and PAYE on the full combined wage and dividend payment they receive.

The Treasury estimates it will be able to recover £350m from these changes, which will affect 250,000 workers - not just in the IT sector - who currently work through an MSC.

The Treasury said in its consultation document: "Even if an individual is working through a company but the underlying nature of the contract is one of employment, tax and NICs should be paid at employed levels. But in the vast majority of cases, MSCs are not complying with this legislation. As a result, the strong growth in MSC schemes constitutes a significant and increasing risk to the Exchequer."

The consultation also proposes that when HM Revenue & Customs can't recover unpaid tax from the MSC then third parties such as recruitment agencies would be liable for the bill.

The UK's Recruitment and Employment Confederation (REC) said that while it broadly welcomes the aim of the legislation, the time frame for its introduction is too short.

Marcia Roberts, CEO of the REC, told silicon.com: "We would like it to be deferred until October. There should be a sensible approach. I think there's limited understanding of the marketplace. Contractual arrangements will need to be changed and with it being the end of the tax year it couldn't come at a more inconvenient time."

She also warned that contractors will look to recover the tax lost through having to switch to PAYE by hiking up their rates. "Going to PAYE they will charge more for their services because it will have an impact on their tax position," she said.

Barry Roback, CEO of IT contractor accountants JSA, warned the new legislation will drive taxation non-compliance underground and push up pay rates.

He said: "It is ironic that the proposed legislation, which was intended to deal with miscreants, will actually make life much more difficult for those who already fully comply with tax laws, while making it much easier for those who are persistent tax evaders."

The Treasury's consultation, which was launched on 6 December 2006, closes on 2 March 2007 and is due to come into effect on 6 April 2007.

A separate study by RM claims almost half (44 per cent) of IT workers are considering giving up their full-time jobs to become contractors.

silicon.com's 2006 Skills Survey also found that lucrative fees are tempting an increasing proportion of UK IT workers into becoming contractors, with those who have no desire to become permanent employees now making up 10 per cent of the IT workforce.