If you're going it alone, the taxman has news for you

Anyone forming a one-man business to supply services should be aware of new tax rules
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The Independent Online

Some 100,000 people in the UK work through their own one-man, or one-woman, service companies. They are usually skilled people - perhaps IT consultants, musicians, oil riggers, teachers or footballers.

Some 100,000 people in the UK work through their own one-man, or one-woman, service companies. They are usually skilled people - perhaps IT consultants, musicians, oil riggers, teachers or footballers.

When he was director-general of the BBC, John Birt (now Lord Birt) had a service company which signed a contract to supply the BBC with his services. (Later, he changed the arrangements to become an employee.)

Why do people do this? In some cases they are genuinely running a small business, supplying services to a number of clients. Using a company gives them greater legal protection. Others are attracted by the tax advantages. Working through a service company can reduce your total tax and National Insurance contributions (NICs) from 35 per cent to 21 per cent.

This tax saving comes about because companies get access to tax breaks not available to employees. For example, company directors can be paid in dividends rather than draw a salary. Dividends are not subject to NICs, which cost the employee 10 per cent and the employer 12.2 per cent. Also, compared with employees, companies obtain more generous tax relief for expenses.

But since April this year, the situation has changed. Under IR35 rules, the Government is distinguishing between individuals working in "genuine" small businesses and those who would be employees of their clients if the service company did not exist. The genuine small businesses can continue as before; the others will be required to pay approximately the same tax and NICs as would be due if the individuals were their clients' employees.

All those working through service companies should check whether they are affected by these new rules. The Inland Revenue's website (www.inlandrevenue.gov.uk) and the website accountingweb (www.accountingweb.co.uk/tax) both have sections that explain how IR35 operates.

If individuals are within IR35, they will be taxed on the income received by the company after the following have been deducted:

* A 5 per cent round sum allowance for expenses;

* Any expenses, such as travel, which would have been allowed had the individuals been employed by their clients;

* Salary and benefits paid to the individual, and the corresponding National Insurance;

* Pension contributions made by the company;

* National Insurance on the amount taxed under IR35 (known as the deemed Schedule E payment).

The principle behind IR35 is deceptively simple: it taxes individuals as if they were employees of their clients. But this simplicity conceals a number of traps. For example:

* Although the company's income may be taxed as if it were the individual's employment income, the company still has to complete a corporation tax return, and may be fined if it does not;

* One of the best ways of reducing the tax and NICs bill is for the company to make pension contributions for the individual. However, this does not work if the individual makes the payments;

* Although the IR35 legislation is aimed at companies, some partnerships will also be caught under the new rules;

* Once the tax and NICs have been paid on the deemed Schedule E amount, it would be reasonable to think that the balance could simply be paid to the individual. But this is not the case. If it is paid as salary it will be subject to further tax and NICs. Instead, the individual should extract the profits via dividends, as specific legislation prevents further taxation if dividends are paid out of money already taxed under IR35.

The tax and NICs for 2000-2001 will be due on 19 April 2001. This sounds like a long time ahead but forward planning will make life easier. It may even be possible to restructure working arrangements so they fall outside IR35 - and the sooner this happens, the lower the tax bill.

* Anne Redston is a chartered tax adviser with Ernst & Young. Her book 'IR35: Personal Service Companies' will be published in September by ABG at £49.50. Copies can be reserved on 020 7920 8991.