SMEs warned about contractor tax obligations

Small and medium sized businesses (SMEs) hiring self-employed contractors are being warned about the risk of avoiding their tax obligations.

A report from said that business owners need to be clear on HMRC rules regarding contractors to avoid falling foul of tax rules and potential penalties.

It said that SMEs could save a total £2 billion in tax by utilising self-employed contractors but that many who are 'disguising' full time employees as contractors are doing so unlawfully.

Businesses have increasingly turned to contractors or sub-contractors following the economic downturn to carry out short-term work or to supply specialist skills on specific projects. Outsourcing staff this way is often more cost effective for businesses than hiring permanent staff.

HMRC regards employees and those working self-employed on a contract basis differently for taxation purposes. For instance, businesses do not normally pay tax or national insurance contributions for contractors.

According to the research, if 15 per cent of higher rate taxpayers transferred to self-employed or contractor status, SMEs could benefit from national insurance savings of around £2 billion every year.

However, it highlights that tax rules in this area are complex, saying: "SME owners have to ensure they are clear on the rules - to avoid utilising ‘disguised employees' and being accused of tax avoidance."

Such 'disguised' employees are considered as those leaving a company to become self-employed, while effectively remaining employed on a full-time basis by a company for the sole purpose of reducing the company's tax liabilities.

Karen Barrett, chief executive of said: "Tax is a vast and complex subject and it can be hard for business owners to find the time to understand how to optimise their tax status whilst also running their business day to day."

"By utilising self-employed workers better, SMEs could be saving tax payments but it also highlights that tax can be a bit of a minefield."

Its 2012 Tax Action report also revealed that SME owners are also failing to take advantage of tax breaks and efficient ways to run their business amounting to £7.1 billion a year. Elsewhere, it found that individual Britons will also pay £12.6 billion in unnecessary tax to the tax man in 2012.

We can help with tax compliance. Please talk to us for more information.