Corporate
and business tax
IR35
Personal Service Companies
The
‘IR35’ rules are designed to prevent the avoidance
of tax and national insurance contributions (NICs) through
the use of personal service companies and partnerships.
The rules do not stop individuals selling their services through
either their own personal companies or a partnership. However,
they do seek to remove any possible tax advantages from doing
so.
Summary
of Approach
Removal
of tax advantages
The tax advantages mainly arise by extracting the net taxable
profits of the company by way of dividend. This avoids any
NICs which would generally have been due if that profit had
been extracted by way of remuneration or bonus.
The intention of the rules is to tax most of the income of
the company as if it were salary of the person doing the work.
To whom does it apply?
The rules apply if, had the individual sold his/her services
directly rather than through a company (or partnership), he/she
would have been classed (by the Revenue) as employed rather
than self-employed.
For example, an individual operating through a personal service
company but with only one customer for whom he/she effectively
works full-time is likely to be caught by the rules. On the
other hand, an individual providing similar services to many
customers is far less likely to be affected.
Planning consequences
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The
main points to consider if you are caught by the legislation
are:
- the
broad effect of the legislation will be to charge
the income of the company to NICs and income tax,
at personal tax rates rather than corporate tax rates
- there
may be little difference to your net income whether
you operate as a company or as an individual
- to
the extent you have a choice in the matter, do you
want to continue to operate through a company?
- if
the client requires you to continue as a limited company,
can you negotiate with the client for increased fees?
- if
you continue as a limited company you need to look
at the future company income and expenses to ensure
that you will not suffer more taxation than you need
to.
The
last point is considered in more detail below.
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Employment v self-employment
One of the major issues under the rules is to establish whether
particular relationships or contracts are caught. This is
because the dividing line between employment and self-employment
has always been a fine one.
All of the factors will be considered, but overall it is the
intention and reality of the relationship that matters.
The table below sets out the factors which are relevant to
the decision.
| The
Revenue will consider the following to decide whether
a contract is caught under the new rules |
| Substitution |
the
individual can do the job himself or send a substitute? |
| Control
|
the
customer has control over tasks undertaken /hours worked
etc? |
| Equipment |
the
customer provides all of the necessary equipment? |
| Financial
risk |
the
company (or partnership) bears financial risk? |
| Basis
of payment |
the
company (or partnership) is paid a fixed sum for a particular
job? |
| Benefits |
the
individual is entitled to sick pay, holiday pay, expenses
etc? |
| Personal
factors |
the
individual works for a number of different customers and
the company (or partnership) obtains new work in a business-like
way? |
Exceptions to the rules
If a company has employees who do not have 5% of the shares
in their employer company, the rules will not be applied to
the income that they generate for the company.
Note however that in establishing whether the 5% test is met,
any shares held by ‘associates’ must be included.
How the rules operate
The company operates PAYE & NICs on actual payments of
salary to the individual during the year in the normal way.
If, at the end of the tax year - ie 5 April, the individual’s
salary from the company, including benefits in kind, amounts
to less than the company’s income from all of the contracts
to which the rules apply, then the difference (net of allowable
expenses) is deemed to have been paid to the individual as
salary on 5 April and PAYE/NICs are due.
Allowable expenses:
- normal
Schedule E expenses (eg travel)
- certain
capital allowances
- employer
pension contributions
- employers’
NICs - both actually paid and due on any deemed salary
- 5%
of the gross income to cover all other expenses.
Where
salary is deemed in this way:
- appropriate
deductions are allowed in arriving at corporation tax profits
and
- no
further tax/NICs are due if the individual subsequently
withdraws the money from the company in a Revenue-approved
manner (see below).
Points
to Consider from the Working of the Rules
Income
and expenses
The income included in the computation of the deemed payment
on 5 April includes the actual receipts for the tax year.
The expenses are those incurred by the company between these
two dates.
In order to perform the calculations, you need to have accurate
information for the company’s income and expenses for
this period. You may need to keep separate records of the
company expenses which will qualify as ‘employee expenses’.
Timing of corporation tax deduction for deemed payment
A deduction is given for the deemed payment against profits
chargeable to corporation tax as if an expense was incurred
on 5 April. This means that relief is given sooner where the
accounting date is 5 April.
Will the company make a taxable loss because of the legislation?
If a company’s expenses are high the company may make
a taxable loss. This can be relieved against other income
or by carry back in the first year of the new rules, but can
only be relieved by carry forward against future trading income
after this.
If you consider that you may be in a similar position, you
need to estimate the effect now. We can help you with the
estimates if required.
One reason why the projected expenses will create a loss would
be where the company pays a spouse a salary. The amount of
the salary may need reviewing.
Pension contributions
Payments made by your company into a personal pension plan
will reduce the deemed payment. This can be attractive as
the employer’s NICs will be saved in addition to PAYE
and perhaps employee’s NICs.
Other
Points to Consider
Extracting
funds from the company
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For
income earned from contracts which are likely to be
caught by the rules, the choices available to extract
funds for living expenses include:
- paying
a salary
- borrowing
from the company and repaying the loan out of salary
as 5 April approaches
- paying
interim dividends.
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The
advantage of paying a salary is that the tax payments are
spread throughout the year and not left as a large lump sum
to pay on 19 April. The disadvantage is fairly obvious!
Borrowing from the company on a temporary basis may mean that
no tax is paid when the loan is taken out, but it will result
in tax and NICs on the notional interest on the loan. There
may also be a need to make a payment to the Revenue equal
to 25% of the loan under the ‘loans to participators’
rules.
The payment of dividends may be the most attractive route.
If a deemed payment is treated as made in a tax year, but
the company has already paid the same amount to you or another
shareholder during the year as a dividend, you will be allowed
to make a claim for the tax on the dividend to be relieved
to avoid double taxation.
The company must submit a claim identifying the dividends
which are to be relieved.
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Example
of payment of dividend
Mr Arthur owns 100% of the share capital of Arthur Ltd.
All the income of the company is caught by the IR35
rules. Accounts are prepared to 5 April 2005. An interim
dividend of £20,000 is paid on 30 September 2004.
The deemed payment on 5 April 2005 is £80,000.
There is no immediate tax cost of the dividends being
paid out either to the company or to the shareholder.
The company will pay tax and NI on the deemed payment
of £80,000 in the normal way ie on 19 April 2005.
The company can make a claim for the £20,000 dividend
not to be treated as a dividend for tax purposes in
Mr Arthur’s hands. Nor will it be treated as a
dividend for the purposes of the new ‘19% regime’
applying in small companies.
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Getting
ready for 5 April
There is a tight deadline for the calculation of the deemed
payment and paying the Revenue. The key dates are:
- the
deemed payment is treated as if an actual payment had been
made by the company on 5 April
- tax
and NICs have to be paid to the Revenue by 19 April
- form
P35 showing details of the deemed payment has to be submitted
to the Revenue by 19 May.
The
Revenue has announced relaxations from the strict requirements
above allowing provisional figures to be calculated and submitted.
However, interest on overdue tax is chargeable from 19 April
if tax and NICs are underpaid on the basis of provisional
figures.
It is therefore in your interests to have accurate information
on the company’s income and expenses on a tax year basis
and, in particular, separate records of the amount of the
company expenses which will qualify as ‘employee expenses’.
Partnerships
Where
individuals sell their services through a partnership, the
rules are applied to any income arising which would have been
taxed as employment income if the partnership had not existed.
In other words, where a partnership receives payment under
an ‘employment contract’:
- income
of the partnership from all such contracts in the year (net
of allowable expenses as described above) are deemed to
have been paid to the individuals on 5 April as salary from
a deemed employment with PAYE/ NICs due accordingly and
- any
amount taxed in this way as if it were employment income
is not then taxed as part of the partnership profits.
Partnerships
excluded from the rules
Many partnerships are not caught by the rules even if one
or more of the partners performs work for a client which may
have the qualities of an employment contract.
The rules will only apply to partnerships where:
- an
individual, (either alone or with one or more relatives),
is entitled to 60% or more of the profits or
- all
or most of the partnership’s income comes from ‘employment
contracts’ with a single customer or
- any
of the partners’ profit share is based on the amount
of income from ‘employment contracts’.
Penalties
Where
a personal service company or partnership fails to deduct
and account for PAYE/NICs due under the rules, the normal
penalty provisions apply.
If the company or partnership fails to pay, it will be possible
for the tax and NICs due to be collected from the individual
as happens in certain circumstances under existing PAYE and
NIC legislation.
How
We Can Help
We
can advise as to the best course of action in your own particular
circumstances.
If IR35 does apply to you we can help with the necessary record
keeping and calculations.
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of page
For information of users: This material is published
for the information of clients. It provides only an overview
of the regulations in force at the date of publication, and
no action should be taken without consulting the detailed
legislation or seeking professional advice. Therefore no responsibility
for loss occasioned by any person acting or refraining from
action as a result of the material can be accepted by the
authors or the firm.
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