Analysis – No fairytale for Alice in Primarololand.

Alice works for EDF, which is an outsourcing company.

Like most outsourcing companies it puts its staff into client’s premises where they largely work under the direction of the client (as the work they do is integral to the client’s administration) although they are ultimately answerable to EDF.

The Primarololand government wanted to encourage employee share ownership.

It devised an all-employee share ownership scheme – remarkably like the one the UK government has included in the Finance Bill. It does not want to benefit major shareholders so provided no-one owning more than 25% of the share capital can participate if the company is a close company.

EDF is indeed a close company. Alice has worked for it for a long time and she has acquired shares in it under earlier all-employee share schemes.

Her total holding amounts to five per cent of the company. She has been awarded an extra 0.001% of the shares under the new all-employee share ownership plan. EDF is a very profitable company. It looks after its staff well, so its overheads are quite high. For every £3,000 of fees generated by Alice, £600 goes in overheads, £1,400 is profits and £1,000 is Alice’s salary. EDF is very capital intensive. It ploughs back most of its profits into re-equipping and Alice expects she will receive modest dividends each year. Lucky Alice?

Er, No. At the same time as it introduced the all-employee share ownership plan the government of Primarololand introduced a special tax charge on work done through personal service companies. This does not worries Alice.

She is a full-time employee of EDF. She believes people who work through personal service companies are evil tax avoiders and fully deserve to suffer the special tax charge. By coincidence the Primarololand personal service company legislation is remarkably similar to that in the UK. Alice worked very hard throughout last year. She is paid a salary of £50,000.

As she has earned £180,000 of fees for the company she is hoping for a holiday bonus and was indeed promised an extra £3,000. The day before her holiday her boss called her in. He was looking very embarrassed. ‘What’s wrong?’, said Alice. ‘I’m afraid,’ said the boss that you owe us £40,137′. Alice looked bewildered. ‘It’s that personal service company legislation,’ he explained.

‘But I don’t have a personal service company,’ said Alice. ‘I know,’ said the boss, ‘but you have worked for us for the whole of the last year for the purposes of our client R Evenue and although their contract is with us, if you had been employed direct by them you would have been an employee of R Evenue.’

‘So what’, said Alice. ‘So,’ said the boss ‘we are your personal service company.’ ‘Don’t be daft,’ said Alice, ‘I am a full time employee and cannot benefit from anything other than my salary apart from the dividend from my very tiny shareholding.’

‘Oh dear,’ said the boss ‘If only you hadn’t joined the employee share ownership plan.’ ‘What do you mean?’ said Alice. ‘The government encouraged me to do so and I don’t own anything like 25% of EDF which I happen to know is where the anti-avoidance rules start to bite.’

‘Oh dear’, said the boss again. ‘Unfortunately as you now own over five per cent of EDF and the shares entitle you to receive dividends I’m afraid personal service company rules apply to you.’ By this time Alice was getting very angry. ‘I received a dividend of £20’ she shouted, ‘how can I possibly owe you £40,137.’ ‘Well,’ said her boss, ‘we have to start with the £180,000 income you generated for us. We can knock off five per cent to cover our overheads and the £50,000 we have already paid you which comes down to £121,000. We deduct £43,137. We promised you a £3,000 bonus so netting that off leaves you owing us £40,137.’

Thankfully Primarololand is an imaginary country. But if you work for an outsourcing company you might just like to have a look at the UK legislation before you join its new all-employee share plan.

– Robert Maas is a partner with Blackstone Franks.

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