Limited companies tend to be the structure of choice for most reasonably profitable businesses, as they allow the owner to minimise tax and National Insurance liabilities. The principal ways of achieving that are a) by being paid via NI-free dividends and b) perhaps by sharing the income with a spouse or partner to use a second person's tax allowances. It's not the right solution for every business, but it's standard tax planning for many.
Through the 1990s, more and more highly paid employees started to use this structure as well, particularly in the IT industry. The man on the street would probably have though that many of these people weren't really running a small business, but really just had a job, but there was nothing to stop them from exploiting this same limited company structure to save tax and NI. They were giving up employment rights, but the often massive decrease in tax and NI bills generally made up for that many times over.
After a while, HMRC got fed up with employees going home on a Friday with their P45, then coming back on Monday, sitting at the same desk, doing the same work, but invoicing their former employer via a limited company, with a consequent drop in the tax and NI going to the Exchequer. In 2000, a rule known as IR35 came in. In very basic terms, it said: if what you're doing really amounts to a job, you can't use dividends to save NI and you can't split income with your spouse to save tax. Your company has to pass pretty much all its income on to you via PAYE salary, meaning the tax and NI take is pretty much what it would have been if you had been on PAYE in the first place.
IR35 hasn't worked that well. Firstly, there are a lot of grey areas in many people's relationship with their customer/employer. Some people had some of the characteristics of employment, but some of self-employment as well. If HMRC decided to try and impose IR35 upon them, it could take years to resolve, and HMRC generally seemed to lose the argument in the end anyway. Secondly, the initial onus is on the taxpayer to put their hand up and pay any tax and NI due under IR35. Almost nobody put their hand up, and HMRC had nothing like the resources to police it. Overall, I would think that even HMRC themselves would have to acknowledge IR35 as somewhere between a disappointment and a failure as legislation.
There's now an attempt to portray as a scandal the number of people being paid via these arrangements by the government itself. It's being painted as a coalition problem, but the truth is that this story could have come out any time in the last 15 years - these arrangements have been commonplace for ages. I completely agree that they are undesirable - it's grossly unfair that highly paid people can afford to put these arrangements in place but that it isn't economical for someone on £15,000 a year - but they're normal. For them to be stopped, it will need either a) IR35 to be changed so that it works or b) tax and NI to be fundamentally changed so that the company route offers no material tax savings. Probably, neither of things will happen. What will actually happen is that a few high profile arrangements will be changed now, words will be spoken about lessons learned, the media will get bored, and then it will be business as usual.
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