Public sector contractors who are deemed caught by the Off-Payroll tax rules and trade via a limited company face a unique set of accounting challenges but are encouraged not to carry on using their limited company if they can.
Astonishingly, HMRC guidance on preparing statutory accounts when the Off-Payroll rules apply defies the fundamental rules of accounts preparation, leaving many contractors and accountants at risk of breaching the Companies Act 2006 the applicable Financial Reporting Standard (FRS).
Like many other aspects of the public sector roll-out, the mad rush to do something, rather than the right thing, trumped all other considerations. Apparently, no one considering the changes noticed that it was impossible to prepare statutory accounts under the new rules, without breaking company law.
The predicament in which many contractors find themselves, short-term solutions are available, and reminds contractors that continuing to trade via their company is essential to any successful challenge to their deemed Off-Payroll status.
Off-Payroll rules: the accounting conundrum for contractors
Where considered to apply, the Off-Payroll tax rules require that company turnover is invoiced and received by the contractor’s limited company. However, the sum paid is to be treated as personal income, with income tax and employee’s National Insurance (NI) having been deducted by the fee payer.
When the contractor’s limited company receives this income, together with the VAT on the pre-tax sum, it isn’t the full value of the sales invoice issued by the company. It will also appear on the contractor’s personal tax return because tax has already been deducted via payroll.
As per the Companies Act 2006 and FRS 102, this income is to be treated as company turnover. But, if you prepare accounts in this way, you begin with a taxable profit in the company on income that has already suffered tax deductions.
HMRC’s guidance on the matter has been minimal, simply suggesting that income is treated as received by the limited company ‘on trust’ and passed onto the contractor either as an ‘untaxable dividend’ or treated as pre-taxed payroll.
There are no provisions within the Companies Act or the FRS 102 permitting income to be treated in such a manner, meaning the taxman is actively encouraging non-compliance with the rules:
Usually a dividend would be taxable, but, in this instance, contractors are encouraged to treat it differently to other dividends; an action which isn’t backed by law. HMRC’s proposals don’t make sense with regards to financial reporting standards, which now require accountants to report turnover and taxable profit in instances where there are none.
Contractors shouldn’t close companies due to Off-Payroll
This issue wasn’t squared off because the Off-Payroll implementation was rushed, and, I suspect, because HMRC assumed anyone affected would just stop using their company,
But, while the taxman may have anticipated mass limited company closures, there are plenty of reasons for contractors to continue working in this manner, particularly for those seeking to contest contentious status assessments.
If a client deems you to be caught by the Off-Payroll tax rules and you doubt their assessment, closing your company and working through an umbrella isn’t going to help you prove your case if you appeal at a later date. Given the number of blanket assessments that we are hearing of, many contractors would be advised to keep trading through their company.
Of course, a lot of contractors will have assignments that vary in type, meaning some work which falls within the scope of the rules and other work which doesn’t. Maintaining the company is always advised to help capitalise on the latter.
How are contractors and accountants navigating the rules?
Pressure on HMRC to update its guidance is mounting. The Institute of Chartered Accountants in England and Wales (ICAEW) has asked that the issue is addressed as a matter of urgency, meaning amendments could soon be forthcoming. Until then, accountants are having to find creative ways to navigate the rules.
Some accountants are using a version of common sense and not putting the payment to the individual through the profit and loss account at all. This way, the money ‘rests’ on the balance sheet until paid to the individual. This tactic is sensible in theory, but it is by no means a robust accounting practice.
Other accountants have opted to declare the income as usual, while reducing profits by the amounts paid out to the individual. Manual adjustments are then made to ensure corporation tax isn’t applied to the notional profit that the accounts would produce.
Though this method prevents the contractor from suffering double taxation, it’s not ideal, as the amount paid to the individual isn’t being treated as usual. As a profession, we hate manual adjustments, namely because HMRC’s treatment of them isn’t documented, but also because we have no standards to hold them to.
In any case, many accountants have begun including an accounting policy note of their own, explaining how they have deviated from standard financial reporting.