He was speaking in the wake of a Guardian story revealing that 25 senior members of staff at the Department of Health have had their salaries paid to limited companies. The practice is also understood to occur in primary care trusts.

The department has apologised after documents sent to the Guardian showed that contrary to assurances given to parliament, more than 25 senior staff employed by the department are paid salaries direct to limited companies, with the likely effect of reducing their tax bills. In some cases, the documents show the named individuals are being paid more than £250,000 a year, as well as additional expenses. The payments amount to almost £4.2m in one year.

Full article here

If you get it wrong

For most contractors, when considering the risks of a tax investigation there are four main tax areas that could be targeted by the HMRC; (a) PAYE, (b) VAT, (c) Company tax, (d) Personal tax. A compliance check may involve one, or several of these types of taxes.  If you are selected for a compliance visit, and are found to have made errors in your tax return(s) the HMRC will apply a tax-geared penalty where your actions have caused a loss of tax. The tax-geared penalty will be somewhere between 0% to 100% depending on whether the error was innocent (0%) to deliberately concealed (100%). A fixed sum penalty may also apply for various reasons. Further, if the HMRC believe the error was due to not taking ‘reasonable care’ they can go back and review your previous 6 years of returns (and if they think you have deliberately evaded tax, they can go back 20 years).

Avoiding a visit in the first place

While a minority of compliance visits are purely random, most are undertaken because the HMRC think there will be something to find. Greater analysis is now possible due to electronic filing of most tax returns, and because annual accounts are also filed in iXBRL. This format means accounts can be easily processed by the HMRC looking for unusual or irregular transactions. Here are my top tips to ensure you fly low across the HMRC radar;

1. File your returns on time. It might sound simple, but its very important. Ensure you know your VAT quarterly filing deadlines, your company tax filing deadline, the PAYE filing deadline (19^th May each year), and get your personal tax return filed each year by 31 January.
2. Pay your tax on time. Just as important as item (1) above, make sure the HMRC receive their money on time. Direct debits work great with VAT, and remember tax bills can be paid by credit card. Regardless of improvements in transaction speed between banks, always allow 3 working days for your tax payment to reach the HMRC;
3. Keep impeccable records – Excellent record keeping is imperative. It shows you are professional in your approach to running your business, and will help answer any queries the HMRC may have regarding any tax or accounting transactions. This includes keeping copies (hard copies or electronic are acceptable) of all your invoices, all your receipts, all your business bank account statements, and any other relevant company documents like share certificates, directors loan agreements, and dividend vouchers.
4. Take the time to review your accounts. Avoid the temptation to simply rubber stamp what your accountant has prepared for you. If a figure looks unusual contact your accountant and ask them to explain. At the end of the day it’s your company, your tax, and your responsibility. You should explain any large variations in the notes on the return.
5. Get specialist advice from the outset. I would never suggest a contractor meet the HMRC one-to-one – always have your accountant on hand, or if the compliance visit turns into an IR35 investigation, engage the services of an IR35 specialist;
6. Don’t cover your tracks. Never conceal anything from the HMRC, and don’t think you can tell half-truths.

Summary

In most cases if your business is selected for a compliance visit it will be because the HMRC suspect you may be doing things incorrectly. If you file your returns on time, pay your tax on time, and explain any large variations to current year figures compared to previous year figures, then you will be sending a strong message that you know what you are doing, that you understand your responsibilities, and that you are running your business in a compliant fashion.

More Information

• The new single compliance process
• HMRC Compliance Check factsheets

The mistake is believed to be thanks to tax officials neglecting to account for a four–fold rise in the number of second payments on account, normally payable by July 31st.

Although it said the majority went out on time, HMR&C conceded that some statements will be issued later – “soon,” though not before the relevant SA reminder letters, which some taxpayers are also yet to receive.

“No one needs to worry about this,” HMRC said of the delays online, before pointing out that taxpayers can check the amount they owe on its website, and settle up electronically.

Still addressing affected taxpayers, the Revenue said they would be afforded 30 days from receipt of their statement to pay, during which time no interest will follow.

It is a general principle of English law is that there is freedom of contract. There are some exceptions to that, particularly where one party is a consumer, but that is the general principle so whatever the parties agree, the court, if called upon to do so, will enforce it by requiring the party in breach to pay compensation to the other party. So it is important to get a solicitor or barrister to draft the contract – if you are in the fortunate position of being able to put forward your own contract wording – or to check the contract if, as often happens, the starting point is a draft contract put forward by the other side.

The form of the contract

The basic deal between the parties – how much one party will pay and what the other party will do in return – is negotiated in principle between the parties. After that, with legal advice, the parties negotiate the detailed terms which make up the contract, before it is signed by both parties and becomes legally binding.

Certain contracts, such as contracts for the sale of land, have to be in writing, signed by the parties, but it is possible (though often not desirable) for most other contracts, including commercial contracts, to be made by word of mouth or by email. If the intention is that there is to be a formal detailed contract signed by the parties, is important when negotiating the basic deal to make clear that it is not intended to be binding unless and until a formal contract is signed. Otherwise you may end up bound by an oral contract which does not contain all the detailed terms you  intended.

Names of Parties

The contract will commence by naming the parties: “This Agreement is made between…”. Particularly where the parties are limited companies, it is important to use the exactly correct legal name of each party. 

Recitals

Most commercial contracts do not have recitals but they can sometimes be useful to set out the circumstances in which the contract comes to be entered into, because, in case of dispute about the correct interpretation of the contract, its stated commercial context can help to clarify any possible ambiguity. If there is a recital it conventionally commences with the words Whereas…. and ends when the operative part of the agreement starts  with the words: It is Agreed as follows:

Definitions

The first numbered clause of a contract usually sets out definitions of key terms. For example the word Work might be defined as “the work to be carried out by the Contractor as set out in  detail in Schedule 1”. The word Work having been defined, it can then be used whenever required later in the contract and its specific meaning will be clear.

Main Commercial Obligations    

In the interests of clarity it is usual to then set out the main commercial obligations – what one party will do and what the other will pay – before setting out all the detailed clauses dealing with, for example,  what happens in exceptional circumstances.

Inability to meet main obligations

One of the main risks when entering into a contract for the provision of services is the possibility of the party providing the services being in breach of contract because of circumstances outside that party’s control such as accident or illness. One approach is specifically to provide that an inability to carry out work due certain specified causes is not a breach of contract. If this approach is taken it is usual to provide that, although there is no breach of contract, the other party can, if delay continues for a specified period, and if that party so wishes, terminate the contract. Unless the price is purely an hourly rate, it will also be necessary to provide for how the price is to be recalculated if the contract terminates early without breach.

An alternative approach is to make clear that the contractor is not obliged to provide the services only using specified individuals and can use any suitable individual. Such substitution clauses allowwork to continue even if a particular person is unwell.

Reducing Risk

A substitution clause reduces the risk of being in breach due to illness of the key individual but it creates another risk in that finding a suitable replacement at short notice may not be easy.

The usual approach when negotiating commercial contracts is for each party to seek to reduce its own risk and deflect risk onto the opposite party, the negotiations normally resulting in some compromise sharing risk. In some cases, however, the shadow of the notorious IR35 legislation causes negotiations to take a different path with the contractor almost welcoming risk as a means of demonstrating that the “hypothetical contract” would not be one of employment.  The possible damage to profits from IR35 is a legitimate concern but at the same time there is a balance to be struck: it may be unwise to seek a small reduction in the risk of IR35 applying at the cost of accepting a large contractual risk.

Limiting liability

Accepting some risk, whilst agreeing an upper limit on liability, is often the goal. Generally the parties can make a binding agreement to limit liability to each other though it is important that the precise terms are correctly stated. Often a party wishes to also limit the liability of its directors/employees to the other party for tortious acts. Since 1999 this has been possible under s.1(6) of the Contracts (Rights of Third Parties) Act 1999.

Ensuring that the contract is not construed as a contract of employment

Where the contractor is an individual person, contracts for services traditionally take some care, not only to state that they are contracts for services (and not contracts of service) but also – because the “label” may not be determinative in law – to set out “for the avoidance of doubt” specific terms consistent with a contract for services and inconsistent with a contract of service.  Where the contract is between two limited companies, the view was sometimes taken in the past that there was less need to do this because a contract between two companies cannot be a contract of service as only a human being can be an employee. However the introduction of the IR35 legislation, with the possibility of a company-to-company contract being used to build a hypothetical company-to-individual contract for tax purposes, means that the same approach should be considered in company-to-company contracts. This is not a matter of shouting from the rooftops that the contract is not one of employment but rather of carefully going through the relevant terms one by one and ensuring that they unequivocally follow the parties intention that this should be a business-to-business relationship. Since the contracting company itself is likely to have a relationship with the individual it uses to carry out the work which comes within worker protection legislation, such as legislation providing for minimum entitlement to paid holiday leave, some care is needed in distinguishing between the position vis-a-vis its own worker and the position vis-a-vis charging the other contracting party.

Entire Agreement Clause

Most formal written contracts have a clause stating that the agreement is the entire agreement between the parties. The effect of this is to make it difficult for either party to subsequently claim that there are additional terms agreed between the parties which are not in the written agreement. Thus is makes for certainty. Of course if such a clause is used it is important that all the agreed terms are contained in the agreement.

Restrictive Covenants

Where the contract is between a contractor and an agency, the agency may seek to include restrictive covenants in the agreement, to prevent the contractor seeking or accepting direct work from the end client for a period of time after the contract ends. The starting position of English law is that it is in favour of the free market and against covenants which limit competition. However the law will uphold some covenants if they are not too widely drawn. From the contractor’s point of view if a covenant is so widely drawn as to be certain to be invalid, and it cannot be removed entirely, it can sometimes be tactically wise to leave it in its invalid wide form, rather than seek to cut it down in which case it may become valid. As with all contractual terms the advice of a solicitor or barrister should be sought. Where the Conduct of Employment Agencies and Employment Businesses Regulations 2003 apply, without a valid opt-out, regulation 6 prevents most restrictive covenants being enforced.

Law and Jurisdiction

If the contracting parties are both English companies, the work is to be carried out in England, and there is no connection with anywhere other than England, the contract will undoubtedly be interpreted in accordance with English law and any dispute subject to the jurisdiction of the courts of England and Wales. However for the avoidance of any possible doubt, and in case the circumstances are not so straightforward, it is usual to have a clause expressly saying this.

Arbitration

It is possible to have a clause providing that any disputes will be referred to arbitration. Many people think that arbitration is an inexpensive and informal means of resolving disputes, compared to the courts, but often the reverse is the case. Arbitration is in fact often more expensive both because the arbitrator himself has to be paid as well as solicitors and barristers (whereas in the courts only solicitors and barristers and the court fee  have to be paid: the judge is paid for by the taxpayer)  and because the courts have a tiered system which limits costs for smaller value claims. Arbitration however does have the feature that it is confidential whereas court hearings are open to the public.

Answer: A deduction may be available for reasonable use of home as your office. The deduction must be based on a reasonable basis. For example if you use one of the four rooms in your house as an office for a full normal working week, you could claim a deduction of 25% of eligible and relevant home costs.

Eligible costs would include a proportion of:
Rent or Mortgage interest;
Gas, electricity, metered water rates, Council Tax, Insurance;
Repairs, decorating, cleaning;
Telephone;
Internet/broadband;
Computer items e.g. printer cartridges, stationery etc

Note: a claim for use of home for business purposes may have possible implications on the capital gains tax main residence exemption when you come to sell your property.

Education

Manuals and text books

A reasonable amount may be claimed for the cost of manuals and text books required for business purposes – receipts required.

Professional subscriptions

Costs for certain subscriptions may be eligible for deduction. These include:
Subscriptions to appropriate professional bodies
Professional journals, books etc
Professional indemnity insurance

See HMRC’s website for further details of allowable subscriptions

Office Costs

Telephone

Business calls from home or a mobile are fully claimable. However these must be itemised and line rental costs and internet cost are not recoverable unless you have a specific separate line for business purposes only. You must retain a copy of your itemised telephone bill.

Postage

Any business related post can be claimed for, original receipts must be provided.

Office stationery

A deduction can be claimed for any stationery such as paper, pens, printer ink you use for business.

Claims must be for a reasonable amount (in line with the business you run) and you’ll need original receipts to validate claims.

The expert was Paul Spindler, a technology partner at Kingston Smith LLP, the chartered accountancy firm.

I have seen a wide range of arrangements, disputes and settlements but have set out below some of those that commonly apply to individual contractors, contracting with companies.

1) Whose contract is this?

You may often find that you do not have the option to work on the basis of a contract of your own as many companies (and most agents) have standard documents that they will provide to you in order to start a project.

Where you are working on your client’s (or an agent’s) standard terms, it is still worth reading through and checking to make sure that those should properly apply to the particular project that you intend to work on (particularly, as issues such as payment, scope and ownership of the results may change from project to project).

Alternatively, for a relatively low fee, a decent solicitor should be able to provide a contract that you can use with your customers and which sets out clearly in your terms the basis on which you intend to work, how and when you should be paid, what you should (and should not) be responsible for and the ownership of assets after termination.

If you are able to, using your own contract to start negotiations, can give an impression of professionalism and also puts you at a significant advantage, not only during the project itself but also in terms of any negotiation before the contract starts and your rights once a project is over, so it can be well worth taking the time to put this together.

2) How and when will I be paid?

This is perhaps the question on most contractors’ minds and deserves to be set out as clearly as possible in the agreement. In particular, one issue to get right at the start is whether the contract is for a fixed price or is on a “time and materials” basis.

Fixed price contracts

The contract may provide for a “fixed price” to be paid either at once or, more likely, when particular milestones are met or acceptance tests passed.

Where this is the case, you will need to be confident that you can provide the work required and are clear about what will trigger payment of the fixed price, as ultimately this is all you will receive, no matter how many hours it takes or costs involved.

An advantage is that, where you are able to provide the services for less than the fixed price there is no legal obligation to charge any less. You know how much you will receive, no more, no less.

Because with fixed price contracts, the contractor takes the risk of the project scope being unclear or unmanageable, a contract of this kind is only advisable where the scope of the contract (the services that you are required to provide) are clearly set out and there is also a clear “trigger” for payment (e.g. delivery of the particular software or services to the customer), which is not dependent on a third party or something subjective. (Wording such as services being provided “to the satisfaction of the client” or acceptance tests requiring the software is to perform “to the customer’s satisfaction” should therefore be avoided for a fixed price contract).

For fixed price contracts therefore, the contractor should make sure that the scope is clear and manageable and that any assumptions are set out in full (together with the consequences of those assumptions not being correct). That way any changes to the scope can be clearly documented (and priced into) the agreement between the parties.

‘Time and materials’ contracts

One common alternative to working on a fixed price contract is a contract on a ‘time and materials’ basis (i.e. the customer pays for your time involved in providing the particular service and also for the goods, software or other materials that you have had to purchase in order to provide that service).

This arrangement is more suitable for projects where the scope is unclear at the beginning of the project or where the proper solution to a problem has not yet been determined. In this situation there is still some scope for ambiguity however, for instance, will “expenses” be recoverable? If so, what limits are there on expenses, do these cover rail travel, overnight accommodation, meals taken when away from home…etc? For the purposes of working out payments due, you may even have to define how long a “day” or a “week” is for the purposes of the contract. A contract paying a rate based on 8 hours’ work, 5 days a week will be much more favourable than one where the rate is based on 24 hours work, 7 days a week (and the sums payable adjusted pro-rata).

A combination of fixed price and time and materials

Many contracts include an element of ‘fixed price’ and some elements of ‘time and materials’ e.g. a basic payment for time and materials but reward payments on particular milestones being met or on final acceptance. From a contractor’s perspective the points to watch out for are a combination of the above (certainty of milestones, scope and triggers for payment and certainty as to whether expenses will be covered).

3) What is the scope of the service to be provided?

This might sound an obvious point, but I have seen many contracts where Terms & Conditions are provided, yet nothing is set out describing what a particular project will involve, or indeed what the contractor’s part in the project will be.

Clearly, where payment is dependant upon a particular milestone being met, or upon actions of other contractors, the scope needs to be as clear as possible.

4) Who owns the (Background and Foreground) Intellectual Property rights in the materials?

As a contractor you may be bringing some of your own know-how, software, designs, confidential information, processes or other property in which you have Intellectual Property Rights with you to provide the services.

Typically, you might anticipate using these Intellectual Property rights when you have finished the contract and start to work for another client. This is not always the case however and, unless the agreement separates “background Intellectual Property Rights” (i.e. the Intellectual Property Rights either party had before entering into the contract) and “foreground Intellectual Property Rights” (i.e. the Intellectual Property Rights created during the course of the project) then it is likely that the customer will require all Intellectual Property Rights to be assigned or licensed exclusively to the customer. This may not always be appropriate, particularly where you intend to use similar know-how, built up over a period of time in order to act for multiple customers.

In order to set out the basis upon which you may work for other customers after any given customer, the agreement should set out how Intellectual Property will be dealt with and in particular, whether Intellectual Property rights are assigned or licensed and the terms upon which that licence operates. (A customer may for instance be willing to allow you to use materials created provided that you do not use those same materials for a competitor). Such a licence however, would need to be agreed as part of the arrangement.

5) What could I be sued for?

One of the risks of being an independent contractor, rather than an employee, is that you are more likely to be sued where things go wrong. Unless your agent has assumed this responsibility it is therefore advisable to have insurance in place to cover this risk.

If you were to cause death or personal injury through your negligence when providing the services or were to act fraudulently you would not be able to limit your liability for losses that are suffered as a result. In respect of other losses however (for instance, where you damage the property of a customer, unwillingly cause the customer to lose an important contract, suffer a computer virus, suffer a security breach or otherwise suffer damage resulting from your failure) you may be able to limit your exposure in the contract.

One common provision which you will want in place is a “force majeure” clause, dealing with your responsibilities in the event that you cannot supply the service for some reason beyond your control. Without this clause you might find that you are liable for your client’s loss, or face an extremely difficult legal battle to show that the contract has been “frustrated” – rendered impossible to perform.

6) What happens on termination?

When you’re ready to start a project it might seem strange to contemplate its termination, but this is another key area to get right if you want to continue providing services as a contractor.

Receiving sufficient notice of termination by the client should give you the chance to seek the next project and to prepare for the end of the agreement.

Agreeing upfront any restrictive covenants and IP issues will help you to get the future contracts and continue to win work in the same sector. Again, if these issues are not dealt with explicitly in the contract then you cannot rely upon them.

7) How formal do contracts need to be, and what about ‘oral contracts’?

Some contractors believe (often wrongly) that if they do not sign an agreement that has been supplied by the client, that they are not bound by it. There is, however, no need for a signature for a contract to be binding, or indeed for any written terms. However, if written terms are provided and work has started on the contract then it is likely that you have already accepted and to be bound by your client’s terms, whether or not you have signed them. An exception to this is where the agreement is marked “subject to contract” or provides that it will not come into force until signed.

Contracts entered into by e-mail are binding in the same way as if made on paper, however if no written document is used then a contract may still have been made between you and the client as a result of a conversation or simply through the course of providing the services over a period of time. The problem with such “oral contracts” is that they are inevitably difficult to prove. Inevitably, when it comes to a dispute, contractor and client remember things differently. As a result the costs of resolving the dispute are escalated and frequently the contractor finds himself in a very weak position.

A well-drafted contract can be a valuable tool for a contractor, can allow you to recover monies that are rightly yours (together with interest), to get paid on time without arguments as to scope and costs and to avoid being liable for risks associated with the wider project. It is therefore worth spending the time to make sure that the contract you have is suitable for the purposes you need it for.

In their ruling, the tribunal judges concluded, “It is clear to us that ECR is a genuine business and therefore not a target of the IR35 legislation.”

After it decided Richardson was a disguised employee through an engagement with Vertex Data Science, HMRC handed her a £50,000 tax assessment in November 2005.

The tribunal applied three status tests – mutuality of obligation, substitution and control – to determine the nature of her working relationship with Vertex and concluded: “ECR operates from a dedicated business area at her home. It has a company domain and website. ECR advertises its services and is a member of the PCG. It has retained reserves and invested in development and has over the years taken on fixed price work for a variety of clients.”

In a press release on the case, the PCG argued that the tribunal’s focus on Richardson being in business on her own account could signal a shift of thinking by tax tribunals. “The classic tests of employment and IR35 status – control, substitution and mutuality of obligation – are increasingly irrelevant in today’s knowledge economy, and can no longer reflect modern flexible working patterns,” the group said.

The ‘flat-rate scheme’ could save sole traders, the self-employed and those with a second source of earned income thousands of pounds in VAT

James Charles – 9 January 2011 Sunday Times

A little-known loophole could save sole traders, the self-employed and those with a second source of earned income thousands of pounds in VAT.

For the past eight years, they have had the option of signing up to the “flat-rate scheme”, and this allows them to charge their customers the new 20% rate but pay the taxman at a much lower rate — and pocket the difference.

The government increased VAT last Tuesday, hitting consumers with higher prices on everything from televisions to gym membership. However, the self-employed and any business owner with a turnover of less than £150,000, such as builders, solicitors and consultants, can partly avoid the increase and pocket thousands of pounds by signing up to the flat-rate scheme.

It allows them to charge clients the new VAT levy but pay the tax man at lower rates — 9.5% for builders, 12% for estate agents and 14.5% for solicitors and 14% for management consultants, for example.

A guest house owner paying 10.5% under the scheme, with a turnover of £120,000 a year, would save an annual £7,600 compared with paying the tax under normal rules.

The rates vary depending on the profession and were adjusted last week when the higher rate of VAT was introduced. However, while the tax rose by 2.5 percentage points, the lower flat rates increased by only 0.5 to 1.5 points, making the scheme even more attractive.

Also, for new businesses the rate is reduced by one percentage point for the first year.

If you are a sole trader or a very small business, you could certainly benefit from this scheme. Certain professionals will be able to pocket thousands of pounds by signing up.

There are a number of drawbacks. Traders cannot claim back the VAT they have incurred on their day-to-day expenses, although this does not include capital costs such as machinery that was more than £2,000. The use of these flat rates is a trade-off against not being able to reclaim VAT on expenditure.

Sole traders and very small businesses can certainly benefit, but it is not the giveaway that it appears to be and some sole traders with large expenses would actually lose out.

So, in another example, if someone providing book-keeping services is registered under the flat-rate scheme, they could charge VAT at 20% on an invoice for £1,000, but would have to account for VAT at only 14.5%, allowing them to pocket the £26 difference.

However, if they themselves have to pay VAT at 20% on supplies costing £2,000, they would not be able to claim back the £400 in Vat that they had paid out and so would be £374 worse off.

Another drawback is that the flat rate is applied to all turnover, including nil-rate and low-rate sales.

People who have registered for VAT as an individual, such as freelance consultants, should also be aware that the flat rate would be applied to income from other sources that would not normally attract a Vat charge.

For example, if the consultant let out their second home, the flat rate of 14% would also be applied to the rental income as well as on their business turnover.

If the rent was £1,000, they would be forced to hand over £140 under the flat rate of 14% and then pay income tax on the remaining £860.

The rules of the scheme mean that all income, including otherwise exempt property rentals that are separate from your business turnover, must be included under the flat rate.

This applies to all those who have registered individually. However, if you are the director of a small business using the scheme, your personal rental income would not be liable to VAT. The only exception is work completed outside the UK, which would not normally attract VAT. This does not have to be included as turnover in the flat-rate scheme.

Self-employed people who struggle to keep all their VAT receipts will find the scheme particularly useful.

It was introduced in 2002 and, despite a very slow initial take-up, about 190,000 businesses are now registered. The scheme is designed to cut administration for small businesses and the taxman.