Accounting and Business Magazine January 2006.

Mike Truman investigates the reported £33m National Insurance (NI) bill for the UK's orchestras.

"Orchestras could be taxed into oblivion," warned Julian Lloyd-Webber, writing in the Daily Telegraph. "£33m tax bill could close orchestras," said the Guardian. At the end of October, most major UK newspapers carried the story that "four out of five orchestras could close" because of an unpaid tax liability. But what were the facts, and what has happened since?

To begin with, the potential liability is not a tax bill, it is a liability for unpaid National Insurance Contributions (NIC). It arises because orchestras have assumed that freelance musicians, who are treated for tax purposes as self employed, were also treated as self employed for NIC purposes. This would have meant that the musicians had a liability to make contributions, but that the orchestras which engaged them did not. Entertainers, however, are unusual in being treated as self employed for tax purposes but as employees for NIC. The result is that the musicians are liable to pay contributions of a different class (Class 1 instead of Classes 2 and 4), which will increase their personal liability for NIC slightly in the future, once the correct rules are applied. More importantly, the orchestras that engaged them should have been paying employers' contributions of 12.8% on all payments over a weekly threshold. This threshold is £94 from 6 April 2005 onwards, but was lower in earlier years. Her Majesty's Revenue & Customs is entitled to go back six years to collect underpaid contributions, although it claims that the orchestras have been misclassifying musicians since 1998.

You'll also find other articles about the issue if you click the following links
MU Petition Text  •  CM Tax Bombshell Briefing  •  NFMS Tax Bombshell Briefing  •  links index -> 33 Million Tax Bill

So why did this problem arise, and why were the orchestras not aware of it? It goes back to an attempt in 1990 by the then Inland Revenue to recategorise most entertainers for income tax purposes as employees, instead of the self employed status that they had previously enjoyed. This particularly affected actors, and two of them (Alec McCowen and Sam West) successfully appealed to the Special Commissioners against being treated as employees. The recategorisation was abandoned, and entertainers remained self employed.

However, for NIC purposes, most actors had always been treated as employees. The majority of actors found this very helpful, as they paid very little NIC on their notoriously low wages, but by making the contributions they qualified for unemployment benefits. Because the definition of employment is broadly the same for NIC and tax, following the McCowen and West cases, actors should all have been treated as self employed for NIC as well.

In order to prevent this, specific regulations were passed in 1998 that sought to make all but the top stars in the entertainment world liable to NIC as employees. These top stars were to escape because they made a significant proportion of their income from residuals and other rights. By 2003, these regulations were found to be inadequate as many other actors also receive residuals, and the rules were tightened up. They are now defined so as to clearly include musicians paid by the day for short engagements.

Whilst theatres appear to have applied the new rules, many orchestras seem not to have understood them. When Taxation magazine approached HMRC for an explanation, it insisted that: "The Musicians' Union, the Society of Musicians and other interested bodies were consulted prior to the change in legislation. It is apparent that orchestras were aware of the change in the rules, because they applied them correctly in respect of those members of Equity whom they engaged."

It would appear, however, that many orchestras did not understand that the new rules also applied to musicians. This only came to light when HMRC realised during routine tax compliance audits of orchestras that there was a general problem. This culminated in a meeting on 20 October with various representative bodies, including the Association of British Orchestras. It was at this meeting that an HMRC representative made the comment that, according to a review carried out by the Revenue of five orchestras, four would not survive if the NIC bill was collected immediately.

This still leaves various questions to be answered. The first is why it took HMRC so long to realise that there was a problem. They told Taxation that: "There are only 250-300 orchestras in the UK. The non-compliance of orchestras was not identified sooner through such audits because they comprise a tiny proportion of the 1.5m employers in the country."

Another question is why musicians had not been pressing to be treated as employees for NIC purposes, so that they too could benefit from claiming contribution-related unemployment benefits. Horace Trubridge, assistant general secretary of the Musicians' Union, says that it has never lobbied for its members to be able to claim these benefits. The answer is probably that musicians tend to get work for a number of separate performances spread out through the year, whereas actors (particularly in the theatre) tend to be either working every night or "resting".

What effect will the change have on the musicians themselves? Musicians will continue to be taxed as self employed, and by default HMRC will collect NIC on a self employed basis under Class 4 as well. If this income has already suffered NIC as an employee under Class 1, the result will be a double charge. However, the regulations allow for an application to exempt the payments from the Class 4 charge.

The rates of charge are different under the two classes. The first £4,895 of income each year is exempt from Class 4 contributions, and a corresponding £94 per week applies for Class 1. However, the rate from that threshold to £32,760 for Class 4 is 8%, whereas the charge under Class 1 up to the equivalent weekly threshold of £630 for employees is 11%. Over these limits the charge is 1% for both. This means that a musician earning £24,895 a year (a little over the average) will pay £300 a year more in NIC when charged as an employee rather than as self employed.

Important as this will be for the individuals concerned, it is the charge on the orchestras which is the most problematic. As well as the £33m in back liabilities, it is estimated that there will be a £6m a year bill going forward. By contrast, the total grants from the Arts Council to the sector each year, some £35m, is only slightly more than the outstanding liability.

HMRC has pointed out that it has no interest in closing down orchestras, and that it will enter into arrangements with employers to settle their liabilities immediately, giving them time to pay.

Discussions are continuing between the Association of British Orchestras, the Musicians' Union, Arts Council England, and the Department of Culture Media and Sport in order to try and reach a satisfactory conclusion with HMRC. It is only to be hoped that they are able to do so.

Mike Truman, Accounting and Business Magazine January 2006,
This article is published with the kind permission of the ABM.

Mike Truman is editor of Taxation magazine, published by LexisNexis Butterworths.

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