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KEY POINTS
- The benefit to temporary workers of signing on with an umbrella company.
- Problem for HMRC in policing the current system of travel expense claims.
- Were dispensations granted by HMRC too easily?
- Will the new legislation adopt the MSC model?
- The need to define an umbrella company.
Alchemists once sought to turn base metals into gold. Today, magicians are more modest, seeking to convert home-to-work travel into the glittering prize of tax-free receipts. Unsurprisingly, this wizardry has attracted attention from HMRC and the Treasury.
Their joint consultation document Tax relief for travel expenses: temporary workers and overarching contracts of employment was published last month. In it they explain the problem, estimate the Exchequer loss, and ask for comments.
The document also explores a second, linked problem: incorrect, sometimes fraudulent, claims for reimbursed expenses.
In both cases the focus is, however, on only two types of organisation involving temporary workers: umbrella companies, and agencies providing 'overarching' contracts of employment. HM Treasury has confirmed to the author that the proposals are not aimed at personal service companies, although this exclusion is only implicit in the text; see paragraph 7.7.
Two solutions are suggested, one aimed at the travel rules, the second targeting the compliance problem. This article discusses these proposals against the wider policy background, suggests alternatives and assesses the risk of collateral damage.
The traditional position
As is well known, the reimbursement of travel between home and a permanent workplace is taxable, while travel to and from a temporary workplace can be paid tax free.
These rules are fairly clear-cut when applied to long-term employees. Traditionally, those on short-term contracts either:
- moved from one contract to another, with each site being a permanent workplace; or
- signed on with an agency, when each job was seen as a separate employment for tax purposes (ITEPA 2003, s 44(2)).
In neither case did the worker receive tax relief on his home to work travel.
The magic umbrella
Today, more and more temporary workers are sheltering under umbrella companies, which provide written contracts of employment. When the workers move from one short-term contract to another, they thus remain in a single employment.
Each location is treated as a temporary workplace, and so home-to-work travel and the associated subsistence is reimbursed tax-free.
Often the umbrella company is linked to one or more agencies, with the workers signing on with the agency being directed to the umbrella before they start work.
Some agencies have gone a step further, creating their own over-arching employment contracts, so that their workers also move from one job to another in a succession of temporary roles under the arch of a single contract. (For simplicity, this article generally refers only to umbrella companies, but should be read as including these over-arching agency contracts.)
The umbrella company contracts with each worker's clients, and submits invoices at the end of each week or month. Once the money is received, the umbrella deducts a fee, pays the worker's expenses, subjects the balance to PAYE and National Insurance and pays it as salary.
The cost
The Government estimates that around 100,000 people are working through umbrella companies, with a further 225,000 in over-arching agency employment contracts.
The impact assessment attached to the consultation document says that, based on HMRC compliance data, the average annual claim for tax-free travel made by each umbrella company worker ranges from £5,000 to £20,000.
Of the total number of workers, 80% are assumed to claim £5,000, with 1% claiming £20,000, and the remainder somewhere in between. Although this range 'is not based on hard data', it does not seem unfairly biased in the Treasury's favour.
The result of these admittedly slightly dodgy sums is that around £300 million is being claimed by temporary workers for travel and subsistence. If no action is taken, HMRC estimate that this will increase by around 20% a year, so that by 2012 the Exchequer loss will reach £720 million.
Policy issue 1: fairness
The document also discusses the fairness issue. It points out that workers using these structures obtain tax relief on travel and subsistence which is unavailable either to traditional agency workers or to individuals who are directly employed on temporary contracts.
The number of traditional agency workers will shrink, however, as the use of over-arching contracts grows, and the document recognises this (at paragraph6.10). This will level up the playing field and eliminate this unfairness, although this is unlikely to be what the Treasury had in mind.
But what about temps who are directly employed? It is true that they cannot access the temporary travel rules, but they usually have other advantages, such as access to the same benefits and pay rates as permanent employees.
The current position is thus one of swings and roundabouts: directly employed temporary workers have a better benefits package; agency and umbrella workers receive tax-free travel costs. It is rough and ready, but, in the wider scheme of things, perhaps not unfair.
The picture is, however, about to change. When the new Agency Workers Directive comes into force, it is expected to give temporary workers engaged via agencies the same rights as permanent staff (once they have been in post for 12 weeks).
Although it is unclear exactly how this directive will work, it will change the balance between different categories of temporary workers. Perhaps we should wait to see exactly how it will be implemented in the UK, before making decisions on the basis of fairness.
Policy issue 2: flexible market
The document accepts that 'business seeks a flexible and adaptable workforce… and workers themselves seek more flexible working arrangements'. It even suggests that it might be possible to retain the status quo in the interests of flexibility, saying:
'The Government wishes to consider whether there is a case for continuing to give relief [for tax relief on travel]...'
In other words, it wishes to weigh up whether or not there are advantages for business and the flexible labour market that outweigh the unfairness.' (paragraph 1.7)
However, the impact assessment sounds more sceptical:
'It has also been suggested that the use of overarching employment contracts to secure relief for travel plays an important role in maintaining the flexible labour market. However, since the majority of temporary workers are not engaged under overarching employment contracts it is unlikely that this has any significant impact on the labour market.'
With respect, this is to look at the problem from the wrong direction. We need to look forwards, not back. Travel rules apart, two major changes are about to hit the temporary labour market.
The first is the Agency Workers Directive, discussed above.
The second is the withdrawal of the staff hire concession, which allowed recruitment businesses to charge VAT only on their margin, and not on the wages paid by the end-user for the worker's services. The Recruitment and Employers' Confederation has estimated that the withdrawal will increase the cost of using temporary workers by £400 million.
The combined impact of the VAT and travel changes is thus around £700 million; the price tag attached to the Agency Workers Directive is as yet unknown, but is expected to be significant.
Policy issue 3: wages
Who will bear these cost increases? In an increasingly tight jobs market, the brunt of the financial pain is likely to be borne by the workers themselves, in the form of lower take-home pay.
This is not an issue addressed by the document.
Instead, it worries that the travel rules encourage casualisation of the workforce, by offering clients 'a convenient alternative to taking on workers directly as employees' (paragraph 6.11).
This focus seems misplaced: in current economic conditions, withdrawal of the tax reliefs is unlikely to encourage end-users to take on more permanent employees; a more probable outcome is lower wages for temporary staff.
In summary, the policy drivers for changing the travel rules are unconvincing. It is likely to have an adverse effect on the flexible market and depress wages; the jury is still out on fairness.
Over-claiming and under-policing
The consultation document also addresses the over-claiming of expenses. Most umbrella companies have dispensations, and their 'abuse' is 'widespread'. Furthermore, controls over expense reimbursements generally is said to be lax.
In most businesses, reimbursed expenses are paid on top of salary, and reduce profits. There is thus an in-built incentive for employers to check expense claims, reimbursing only those which are legitimate. In general, too, bosses know where their employees are and what they are doing; a worker would have to be foolish as well as dishonest to seek reimbursement of a £300 round-trip to Wick if he had spent the whole week working in Wolverhampton.
In an umbrella company, the higher the worker's expenses, the lower his taxable pay. Business profits are not adversely affected, but rather the reverse; higher expense claims mean lower employer National Insurance.
Furthermore, the umbrella does not and cannot know where its workers are from day to day. The expense review team may exercise common sense, carry out random checks, and ask for receipts, but they cannot really tell whether or not a journey was a business need, or simply a personal indulgence.
Dispensations
The issue is exacerbated by dispensations. Most umbrellas have dispensations for commonplace items such as overnight accommodation. Some have an impressively long list, covering computer hardware, consumables, business calls, Internet connections and entertaining.
Dispensations may require the employer to check receipts before reimbursement, but, according to HMRC, compliance with these requirements is frequently poor. The document says (at paragraph 6.2):
'Some umbrella companies and employment agencies often urge their employees to claim the maximum amount their dispensation allows, regardless of whether these expenses were actually incurred.'
Scale rate allowances take the problem a stage further. Several umbrella companies have agreements allowing workers to claim, say, £35 a day for meals and £30 for an overnight stay, without the need for receipts. HMRC say that many individuals simply claim the maximum, even though they may have spent less, or nothing at all.
he first and most obvious question is why these dispensations and allowances were granted in the first place. The difficulty, apparently, is that HMRC have no way of identifying the umbrella companies in advance.
The tax office receives a fairly standard dispensation request, and, in the interests of reducing red tape, agrees it, only to find out later that it is an umbrella with 3,000 temporary workers.
Secondly, since no information on dispensed expenses or scale rate allowances is included on the P11D, HMRC is unaware of the extent of the sums involved unless (or until) it investigates the company. Then the dispensation may be withdrawn, sometimes retrospectively. At paragraph 3.24 the document says:
'Where it is apparent that negligence or misrepresentation has taken place and expenses and benefits were provided under a dispensation when they should have been subject to income tax and National Insurance, HMRC will pursue retrospectively the income tax and National Insurance liabilities due.'
Given these problems, it must be particularly galling for HMRC to see umbrella companies using dispensations as a marketing tool.
One boast is included at box 6.1 of the document, and reads: 'What makes XXX so unique from other management companies? XXX has a very generous dispensation scheme approved by the Inland Revenue.'
Proposed solution: compliance
A key problem for HMRC is that, when compliance failures are identified, the 'umbrella companies may have little or nothing in the way of tangible assets and can simply wind up and move their workers to a new company' (paragraph 6.5).
The document seeks to block this easy exit route, by introducing a transfer of debt provision similar to that applying to managed service companies (MSCs).
If the proposed new legislation follows the MSC model, it will give HMRC the power to collect underpaid income tax and National Insurance, firstly from the umbrella's directors, and then from the employee, agency and/or end-user. In their published guidance on MSCs, HMRC say that they will not use this power if the third party was 'unwittingly' involved.
In the context of MSCs, the aim of the transfer of debt rules was deterrence, not tax collection. This proposal has the same aim: the impact assessment says 'HMRC does not expect to have to invoke the legislation too often because any measure would act as a deterrent to non-compliance'.
But what is the Government seeking to deter? In the case of MSCs it was clear: agencies and end-users generally knew the nature of the organisations with which they were contracting, and they could decide whether or not to run the risk of continuing to do business with them.
Third parties reluctantly agreed to the draconian transfer of debt rules, for the practical reason that knew they would not apply: instead, they simply ceased to deal with MSCs.
Will third parties have to make a similar decision in relation to umbrella companies?
Fortunately there is no suggestion that umbrellas should be placed, with MSCs, beyond the fiscal pale. Instead, the impact assessment indicates that the debt transfer rules would be used when 'HMRC compliance activity detects a failure to comply with the tax rules, such as an abuse of dispensations [and where] the business could not pay its debt to HMRC'.
In contrast to the position when debt transfer rules were introduced for MSCs, third parties will not have a clear decision to make: how will they know whether, or to what extent, the umbrella polices its dispensations, for example? What is to be the threshold for non-compliance? Few companies have never wrongly reimbursed an expense.
The Treasury should thus expect much greater resistance to these proposals than they faced with MSCs, at least to the extent that they involve third party agencies and end-users. A more limited transfer of debt to workers and to the directors and officers of the umbrella companies may be possible, although this, too, is not without problems.
Proposed solution: travel rules
The document also proposes that new legislation should be introduced in next year's Finance Bill, which would treat each engagement as a separate employment and its location as a permanent workplace.
This seems simple enough, and mirrors the current rules on agency workers. The problem, however, is one of definition. How is an umbrella company to be defined? If HMRC can crack that, they have a chance of succeeding. But it will not be easy.
There is a risk that any definition will accidentally catch other structures, such as personal service companies, or other small businesses. Tax relief for temporary travel is an important and valuable relief: it is essential that any legislative change is narrowly targeted, and does not cause collateral damage.
Third option: do nothing
There are difficulties, therefore, with both the proposed solutions. Maybe the Government should do nothing: this is the third option put forward in the document. It may happen if:
'the evidence from the consultation demonstrated that the potential problems… were not significant or that there were negative consequences for business and the sector which outweighed the benefits of taking action.' (paragraph 7.9)
But, given the increasing cost, this seems unlikely. So is there another route?
Fourth option?
The root of the problems discussed in the document lies in the fact that umbrella companies are unable to police the expenses in the same way as most businesses. The reason for this is simple: the umbrella company has no control over the individual.
A similar issue was identified in an employment tribunal case called Osborne v (1) The United Kingdom Atomic Energy Authority (UKAEA) and (2) Brookson Engineering (1622) Ltd [2003].
Mr Osborne worked for the UKAEA via what would now, probably, be regarded as a MSC. Much of what was said in the case could, however, equally well apply to umbrella companies.
The tribunal decided that Mr Osborne was not an employee, because UKAEA did not direct him in any way nor have any control over him and 'in fact, it really had no knowledge of where he was'.
Absence of control precludes the existence of an employment as a matter of law; see Ready Mixed Concrete Ltd v Minister of Pensions and National Insurance [1967] 2 QB 497. The fact that the individuals have signed employment contracts with the umbrella company does not mean that the work they are doing for their end users falls under that contract: because there is no control, it cannot.
The so-called employment status may thus be, as the tribunal said in Osborne, 'a legal fiction'.
If this is right, what is the status of the workers? If they are paid via an agency, the agency rules may apply: responsibility for PAYE and National Insurance contributions would then fall on the agency and the tax reliefs relating to temporary workplaces are automatically disapplied.
If the umbrella contracts directly with the end user to supply the worker, the umbrella itself may be within the definition of an agency for tax purposes, see ITEPA 2003, s 47 and the Employment Status Manual at paragraph 2002.
This is not a comfortable analysis for those working via umbrellas, for agencies, and possibly not even for HMRC. But it may repay further consideration. It could provide an alternative route, allowing us to avoid both the definitional problems of new legislation and draconian debt transfer provisions.
Conclusion
Despite some hints in the impact assessment implying that Government has already decided to introduce both the transfer rules and new legislation, other indications are that this is a genuine consultation.
The gates are open until 13 October, but given that this date is likely to be close to the Pre-Budget Report, earlier responses may have more impact.
The document can be downloaded from the current consultation sections of either the HM Treasury or HMRC websites. Comments should be sent to travelconsultation@hm-treasury.x.gsi.gov.uk.
Anne Redston is a visiting professor at King's College, London and sits on the Technical Committee of the ICAEW Tax Faculty. She can be contacted at anne.redston@kcl.ac.uk. The views expressed are her own.
