The Treasury is finalising plans to overhaul tax rules which allow self-employed people to avoid paying national insurance contributions.
The move will be targeted at people who set themselves up as private companies to take on work. The BBC understands it could be announced in this month’s Budget.
The Treasury believes a third of people claiming self-employed status as a “personal service company” are actually full employees and should pay more tax.
It says without reform, high levels of non-compliance with tax rules could cost HM Revenue and Customs, which collects taxes, £1.2bn a year by 2023.
It is now looking at demanding that firms which use personal service company contractors take legal responsibility for ensuring “off-payroll” contractors stick to the tax rules known as IR35.
A similar move in the public sector on “synthetic” self-employed has raised £410m extra in taxes since 2016, HMRC estimates suggest.
Full employees pay higher levels of national insurance compared with the self-employed.
Philip Hammond is under pressure to raise taxes at the Budget following the Prime Minister’s pledge of £20bn worth of extra spending on the NHS by 2023.
Personal income tax allowances could be frozen, despite a Tory pledge at the 2017 election that they would rise to £12,500 for lower rate taxpayers and £50,000 for higher rate taxpayers by 2020.
Freezing them could raise up to £2bn a year. Reform of the IR35 rules would not raise as much, but might be less politically controversial.
In March 2017, the chancellor failed to gain Parliamentary support for an increase in national insurance contributions from the self-employed and had to abandon the move.
Without a majority in Parliament, the Conservatives know that any major changes on tax might be voted down.
Representatives of the contracting industry are also likely to react with anger at the proposed changes.
They point out that freelancers charge more for their services than they would if they were “employed”, so any tax gain would be wiped out, as incomes on which tax is paid would be lower.
It is also argued that the public sector reforms on who enforces the rules have been beset with difficulty.
“The Treasury’s claim that it is losing money is based on an ideological flaw and fails to acknowledge the ‘freelance premium’ that individuals charge for their services, compared to what they earn when they are in full-time employment,” said David Chaplin, chief executive of Contractor Calculator which gives advice to self-employed workers.
“That fact alone should blow IR35 out of the water, yet HMRC maintains that individuals are avoiding tax.
“This isn’t true. HMRC’s own calculations demonstrate that 84% of the perceived tax loss where an individual is engaged via a personal service company results from the hiring organisation not having to pay employer’s national insurance.
“Despite this, HMRC continues to suggest that flexible workers are responsible for this perceived shortfall.”
The Association of Independent Professionals and the Self Employed (IPSE), agreed with Mr Chaplin.
Its deputy director of policy, Andy Chamberlain, said: “Business groups have been almost unanimous in their view on this issue.
“Businesses will not be ready to implement such a measure in April 2019. If the chancellor does push ahead with this, he will be flying in the face of the very businesses he pledged to support less than two weeks ago at the Conservative Party conference.”