All that glitters to IT contractors may not be gold

It may surprise you to know that the current Olympic gold medals are over 90% silver, not 100% gold. For contract IT professionals, this fact is more applicable and relevant than it might seem at first. After all, the IT contracting marketplace has seen tremendous growth in 'employment schemes' that boast of delivering you 80% of your fees, or more. But are these schemes what they seem, and do they live up to their promises?

As a former inspector of taxes for the Inland Revenue (now HMRC), and given my more recent role as Employment Tax manager (which involved 'Due Diligence' work), I can't help but notice that a number of schemes promise over 80% of your fees amid currently high levels of UK tax and National Insurance Contributions (NICs).

Contractors approaching these schemes should consider the following areas, carefully, to help deduce if these schemes work, quite apart from whether or not they live up to their own hype.

Location, Location, Location

Whenever I carried out a due diligence test on one of these '80%-plus of your income' schemes, the first thing to consider is where is the company based. Some of the companies providing the schemes are based in Jersey or the Isle of Man, and some appear reluctant to tell you. Maybe, some businesses are based in these locations because they like the "sea air". On establishing the real reason, find out if the business recently moved to this location, and ensure you know how long the company has traded. And assuming the company has a web address, who owns it and where are they contactable? Normally a search on Whois.net can help.

Answers on a URL

FAQs
Many businesses running these employment schemes have a Frequently Asked Questions section on their website, where they highlight the many queries that have been raised already. Like the location of the business, these are very important to read up on and consider in deciding if you wish to use the service.

Testimonials
On their websites, many employment scheme providers have quotes from supposedly satisfied customers. Contact the provider and ask if they are prepared to let you contact a couple of these customers, to help you decide whether to use their services.

Contact
Almost all of the websites advertising employment schemes have contact pages. But how quickly do they answer your e-mails or telephone messages? And looking at the responses they gave you, did they directly address the issues you raised, or did they provide "stock answers" similar to the FAQ section? In any due diligence test, anything less than a tailored personal response should count as a mark against them.

Their clients' working practices

Some employment schemes that promise high returns operate by reducing gross pay (liable to tax/NICs) and replacing the shortfall with a "tax-free" allowance to increase the "take-home pay". As a prospective customer, you need to ask: are the workers really mobile workers, working at a succession of temporary businesses? Or , and potentially more problematical in the event that HMRC investigates, are they actually working at their normal place of work? The difference is important.

HMRC 'approved'

Often businesses behind employment schemes claim to have HM Revenue & Customs (HMRC) "approval". It is very unusual for HMRC to give approval to any schemes. When I worked as a HMRC compliance officer and as a Tax Inspector, I never gave written approval to any schemes in 17 years. If businesses have HMRC approval then they will usually be more than happy to show you.

Businesses sometimes make this claim meaning that the "approval" is an agreed dispensation. A dispensation is an agreement between an employer and HMRC that certain expenses/ benefits are not liable to tax/NIC and do not need to be declared on benefit forms P11D. In most cases, HMRC will rely on the information supplied by the employer, without further checking. After all, there will be a HMRC compliance visit every 5-6 years (on average) to check the expenses and benefits in more detail. It is highly unlikely however, that HMRC would agree that a dispensation is their official agreement to any employment scheme operated by the employer.

Answers on file

In a recent due diligence case, when I asked for all the paperwork for the employment scheme, I was privileged to receive all their accountants' papers and their legal instructions. It took a few hours to prove to the tax partners and to the bank (who were considering the refinancing) that the scheme didn't work and the liability was increasing at the rate of £65,000 a month. Within weeks, the scheme was stopped. Although Companies House can prove helpful, many individuals wanting to know the financial footing of the employment scheme provider will not see these privileged papers.

Put the 'u' in 'due diligence'

In summary, contractors approaching employment/payroll schemes that offer '80%+ of take home pay' should check as many supporting details as possible. Check the provider's website(s); any literature they produce and, ideally, find creditable details of satisfied customers. This is imperative because, of course, HMRC also have access to the internet. Related to this, and from discussions I've had with ex-HMRC colleagues, some of these employment schemes will be challenged in the near future.

It therefore remains to be seen if the recent problem of many IT contractors failing to get paid, because of financial troubles for their provider, is a one-off, or merely the tip of the iceberg.

Comment and guidance from former tax inspector Ray McMahon, a consultant at Consultant365.