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Treasury publishes open letter on tax changes

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A lot has been written about the changes we announced in the Budget to stop avoidance of tax and NICs [National Insurance Contributions] by people using personal service companies. I want to explain why we acted.

The problem arises where an individual is doing a job in circumstances which would normally make him an employee of a large business. For instance, he may work in the offices of that business, for a set number of hours a week, as part of a team led by an employee of the business. But this individual has set up a one-man company. That company has a contract with the business (his client) to provide the services of the individual. The client can then pay the company a fee, without deducting tax or National Insurance Contributions, or paying employer's NICs. The individual can take money out of his company in a variety of forms: he can pay his wife a salary, he can claim a wide range of expenses, and he can take the rest out as dividends on which no NICs are payable. This way of working is common in the IT industry, though it also happens in other industries as well.

The result is that the worker pays a lot less in tax and NICs than he would if he were an employee of the client. In some cases no NICs at all. We don't think that is fair to the other taxpayers who have to pay more as a result.

Legislation to introduce the new rules is included in the Welfare Reform and Pensions Bill, which is about to return to the Commons from the House of Lords. The Government was defeated in the Lords on this, but the Chancellor and I believe it is important that we should press on. That is why we intend to reinstate this measure in the House of Commons.

Some groups in the IT and engineering industries have campaigned against the measure. One of the groups says that its members earn an average of 45 pounds an hour - that's about 1,800 pounds a week. Yet they can pay no NICs at all - less than a nurse, a teacher, or a self-employed plumber. Let me answer some of their arguments.

They say that we haven't consulted them.
We have in fact conducted an unusually extensive consultation. We announced the measure a year in advance. We sent out over 1,700 copies of our proposals, and the Inland Revenue held meetings attended by 38 representative bodies. And we have listened to what people were saying by announcing changes to the proposals in September which met the main concerns expressed during the consultations. The only people who are now complaining about the consultation process are those who want us to let them continue to avoid tax and NICs and are disappointed that we have not backed down.

They say that this measure will destroy the IT industry.

This is not just about the IT industry; there are plenty of people in the IT industry who do not use service companies, just as there are many people in other industries who do. Our support for the IT industry is on record. And we have put in place many measures, such as the 10p starting rate of Corporation Tax, to support genuine small businesses. What we are doing with this measure is ensuring that people who meet the accepted definition of employee pay tax and NICs on the same basis as all other employees.

But we have listened to argument put to us that the flexibility provided by service companies was valuable. Our revised proposals therefore made sure that this flexibility could continue, as long as the workers paid a fair share of tax and NICs.

They say that consultants who work for short periods for different employees should be treated as self-employed.
What they are asking for is in fact more favourable treatment than either the self employed or employees. But our proposal would apply the same rules to consultants as are already applied to a whole range of other workers, including other temporary or casual workers, to decide whether they are employed or self employed. They are based on the courts' decisions in a series of real life cases. If, using those rules, the worker would be self-employed, he will not be self-employed, he will not be affected by our legislation.

They say that the proposals will favour big foreign firms over small UK businesses.
The proposals will prevent a form of avoidance which is only available to workers who control their own service companies and can use them to decide the form in which they take their income to minimise tax and NICs. This is not an issue for big companies which cannot be used by employees to manipulate the form of their income. Where there is evidence of tax avoidance by large companies we are just as ready to act against it. The real competition we should be concerned about is the competition between people who are employees, and others doing substantially the same job but using a service company to pay much less in tax and NICs. That is unfair and we shall stop it.

They say that the measure will cost the UK economy eight billion pounds.

One of the IT groups has commissioned research which claims that the cost to the UK economy will be huge. But the way in which this figure has been calculated doesn't bear a moment's scrutiny. They have asked their members how much extra they would like to be paid if they had to change their way of working in response to the legislation. They have then just multiplied the answer by their estimate of the number of workers affected. It's not surprising that the result is a big number. They have not attempted to find out whether the clients would be prepared to meet these demands.

Most of the responses we received from the consultation process this summer acknowledged that there was a problem, and that it was legitimate for the Government to tackle it. There were criticisms of the method we originally proposed, and we have listened and made changes. What we now propose is fair, targeted and proportionate. It allows the flexible market for skilled labour to continue, using service companies, but ensures that those concerned pay a fair share of tax and NICs. ®

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