Personal Service Companies:
IR35 Legislation Update
Specific legislation was introduced in 1999 to target perceived tax avoidance by employees who where leaving their job and then performing the same tasks through their own limited companies (Personal Service Companies – PSC).
This type of planning allowed the individual to remunerate themselves via a small salary and dividends, the result being an overall reduction to their tax exposure and removing them from National Insurance contributions completely. From the employer’s perspective this planning avoids employers NICs and removes employment rights from the individual.
The anti-avoidance legislation introduced in 1999 (known as IR35) was designed to try and stop this type of planning.
IR35 requires the PSC to assess each of its contracts to determine whether or not in the absence of the PSC the relationship between the individual (director and shareholder of the PSC) and the engager (the business to which the individual’s services are supplied) would be that of employment rather than self-employment.
If the relationship on a particular contract would be that of employment but for the existence of the PSC, the PSC is required to pay a tax charge, the effect of which largely removes the benefit of the individual operating through a limited company.
HMRC’s problem with IR35 is twofold:
- There is no statutory definition of what exactly constitutes employment, and therefore HMRC’s guidance states that each contract has to be examined and decision reached based on the facts. This leaves a significant grey area where the taxpayer and HMRC very rarely agree. Case law has historically favoured the taxpayer, and so
- Less than 10% of PSC’s volunteer the additional tax charge under IR35.
The result of this is that the vast majority of PSC’s operate a small salary and dividend based remuneration policy irrespective of this legislation.
Summer Budget Impact:
Since the introduction of IR35, various governments have tried to make it more effective from HMRC’s perspective, and in the Summer Budget, George Osborne announced that HMRC would consult with businesses on how to make this legislation more “effective”.
The introduction of the new tax charges on dividends from April 2016 will go some way towards making this type of structure less appealing; however, despite this on 17th July, HMRC published a discussion document on IR35.
A copy of this document can be found here.
There are a number of suggestions included in this document, and one welcome change suggested would be to clarify exactly what constitutes employment for these purposes, and remove contracts that do not last for a certain length of time from these rules.
However, the main emphasis of the document is the possibility of shifting the burden of considering IR35 from the PSC to the engager. This would mean the engager making payments to a PSC would need to consider whether or not to put any payments to the PSC through their payroll. This would not only increase the NICs and administrative burden, but also (presumably) place any risk of non compliance with IR35 with the engaging business, and not as currently with the PSC.
From the PSC’s perspective, they would need to convince the engaging business that IR35 doesn’t apply (on the basis that the relationship is not one of employment). This may not always be possible and the engaging business may either request some form of indemnity is included in the business contract, or they may apply IR35 to avoid any possibility of HMRC looking into their affairs. If the engager does apply IR35, the net tax effect of the individual operating through the PSC will dramatically increase, and if the PSC disagreed with the engager’s treatment they would need to claim it back from HMRC.
The fact that HMRC are looking to bolster IR35 is nothing new, however, the proposal to shift the burden of compliance from the PSC to the engager is. As this is currently only a discussion document, no immediate action is required, however, any individuals providing their services through a PSC and any businesses whom have contracts through which they make payments to PSC’s need to be aware of the potential for change to happen in the future.
In conjunction with the various professional institutes and organisations with which we are affiliated we will be participating in responding to HMRC on their proposals. As soon as any further information is available we will be letting our clients know.
You can download the latest edition of Talking Tax here.