New tax rules affecting small limited companies could lead to a shortage of IT contract workers and stifle economic recovery.
Chancellor Gordon Brown announced in last month's Budget that such companies would pay 19 per cent corporation tax on all profits paid as dividends. Currently, the first £10,000 of dividend income is exempt.
But in a survey of almost 500 limited-company contractors by payroll service provider Giant, over half indicated that they would change the way they operate rather than face the tax hike.
Of these, 48 per cent claimed that they would move into full-time employment or work overseas.
Matthew Brown, managing director of Giant, said: "As the economy rebounds businesses need to take on contractors to handle new projects and increasing workloads.
"If there are not enough temporary workers in the market, then businesses will face a skills shortage and rising contract costs."
The Chancellor suggested that the change simply closes an unfair tax loophole. But Matthew Brown believes that the move could undermine the government's stated strategy of encouraging a more flexible economy.
"Profits are only just starting to grow again after a long period of stagnation in the contracting market so this new tax is unfortunate timing," he said.
"If there are fewer contractors overall, that could be damaging for UK Plc. It will mean a less flexible allocation of skills across the economy which could harm our long-term competitiveness."
Since the introduction of the IR35 tax rules in 2000, many contractors have switched to working through third-party umbrella or composite companies. The new tax rises are expected to accelerate this trend.
Over half of those contractors intending to give up their limited-company status maintained that they would be most likely to join this type of organisation.
"The services offered by umbrella and composite companies are growing in sophistication all the time," said Brown.
"Contractors that work through them have more flexibility and enjoy many more benefits without any of the administrative burdens."
He added that other benefits of working in this way can include free contract reviews and insurance for IR35 and professional indemnity, as well as generous expense allowances.
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