Treasury's freelance tax plans could drive up IT fees

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Chancellor Gordon Brown has outlined the Treasury's plans to stop contractors from evading tax using managed services companies (MSC), but some are warning that the changes could drive up IT consultants' fees.

Released as part of Brown's budget report, the changes to the contractor tax system, which come into effect April 6 mean IT contractors using the MSC system will either have to switch to a limited company or change their contracts with companies and recruitment agencies to avoid being more heavily taxed.

By using MSCs, some freelancers can avoid setting up their own limited company and gain tax advantages. The new legislation means contractors using MSCs will pay taxes the same way as standard employees, which means a higher cut will come out of their wages.

Brown first announced the changes in his pre-budget report in December, and a consultation for the legislation closed last month. Since then, a few changes have been introduced, including a tighter definition of an MSC and a delay to disputed debt-transfer rules.

The Treasury suspended until January 2008 the implementation of debt transfer rules, which would have allowed the government to go after third parties for unpaid taxes. If an MSC skips out on paying, recruitment firms and even client companies could be held liable.

"This gives us more time to discuss in more detail who would be liable and who wouldn't," said Jeff Brooks, the IT sector group chair for the Recruitment and Employment Confederation (REC).

The rest of the rules will go forward in April, but with a tighter definition of an MSC, the legislation is a bit clearer. According to the Professional Contractors Group (PCG), now that the definition of what constitutes an MSC has been "significantly tightened," it's clear that contractors using limited companies - where they start their own one-person company - are not included, nor are recruitment agencies or accountancy firms which handle freelancers' pay.

"The key difference we've been lobbying for is to ensure recruitment and employment agencies are not considered an MSC - that has been agreed," said Brooks.

Despite that good news, the tax changes could mean IT contractors' rates face even more pressure. A recent study suggested skills shortages are already pushing such rates up 17 per cent.

"The government has shot itself in the foot. Pressure on contractors is going to force rates up," said Dave Chaplin, chief executive of ContractorCalculator.co.uk. "If less permanent staff are going to switch to contracting, it will reduce the number of contractors in the market, so rates will go higher. With government spending more money on IT, it's not good for them either."

Brooks agreed that one-person limited companies will pay more tax, but said any increase in IT contractor charges will likely not be seen until the end of the year, when they realise how much more they'll be paying, he said.

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