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Personal service companies : recent debate

Published Friday, June 23, 2017

The 'IR35' rules to prevent the exploitation of personal service companies for tax avoidance were introduced in April 2000, following a long and contentious consultation exercise. This legislation remains unpopular among freelancers who use this corporate form to provide services. This note looks at recent debate on how these rules might be reformed and wider concerns about the use of employment intermediaries to avoid tax.

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In April 2000 the Labour Government introduced new rules for the tax treatment of personal service companies in the light of concerns that this corporate form was being exploited to avoid tax. 

Individuals working in a number of fields often provide their services to clients through a personal service company (PSC), rather than taking up employment with that client.  The client pays the service company for the work they have done, without deducting income tax under PAYE or National Insurance contributions (NICs). There are several possible tax advantages to this type of arrangement.  First, the range of expenses which the PSC may set against its taxable profits will be much wider than that allowed an employee to set against his taxable income.  Second, there will be a cash-flow benefit in avoiding tax being deducted at source each month.  Third, the individual may be in a position to receive dividends out of their service company, as an alternative to only being paid a salary, and this form of income would not be subject to NICs.

After a long and contentious consultation exercise, provisions were introduced in the Finance Act 2000 with effect from the 2000/01 tax year.  The rules cover any engagement where: a worker provides services under a contract between a client and an intermediary; and, but for the presence of the intermediary, the income arising would have been treated as coming from an office or employment held by the worker under the existing rules used to determine the boundary between employment and self-employment income for tax purposes, if the individual had contracted directly with the client. In these cases, the intermediary is required to account for tax on this payment in just the same way as employee earnings (ie, charge income tax under PAYE and Class 1 NICs). This legislation governing intermediaries is often referred to as ‘IR35’, after the number of the Budget press notice which first announced this measure.

Although IR35 remained controversial in the decade after its introduction the Labour Government showed no interest in withdrawing it.  In July 2010 the Coalition Government announced the newly-established the Office of Tax Simplification (OTS)  would review small business taxation, and this would include exploring “alternative legislative approaches to IR35.”[1]  The OTS completed its report just before the 2011 Budget. It set out several options for reform, including a merger of income tax and NICs which would make IR35 obsolete.  In the absence of major structural change the OTS suggested that IR35 might be suspended with a view to being abolished, or amended to exempt certain businesses, or retained but with certain changes in their application.[2]  In the 2011 Budget the Government announced that IR35 would be retained “as abolition would put substantial revenue at risk,” though its administration would be improved.[3] 

In 2012 there were concerns about the numbers of senior staff in the civil service being employed through a PSC.  In May that year the then Chief Secretary to the Treasury, Danny Alexander, gave details of a review of these arrangements, and of changes to the way departments could appoint individuals ‘off payroll’. The Minister also announced a consultation – foreshadowed in the 2012 Budget – on amending IR35: in brief, anyone providing their services through a PSC who had been taken on with a senior, controlling role for their client would be taxed as an employee.[4] In the Autumn Statement the Government announced it would not proceed with this proposal “because HMRC’s new approach to policing IR35, along with the measures introduced in the public sector this year, are sufficient to prevent the loss through disguised employment in this way.”[5]

In in its first Budget following the 2015 General Election, the Conservative Government confirmed it would “engage with stakeholders this year on how to improve the effectiveness of existing intermediaries legislation.“[6] A discussion document was published later that month; responses were invited by the end of September 2015. The document made clear that “if the government decides to proceed with reforming the rules, any proposals will undergo a full consultation so that interested parties can contribute their views for consideration.”[7]  One question raised was whether the onus for determining whether IR35 applied or not should be placed on the client, rather than the PSC: “under such an arrangement, those who engage a worker through a PSC would need to consider whether or not IR35 applies (in the same way as they would need to consider whether a worker should be self-employed or actually be an employee), and, if so, deduct the correct amounts of income tax and NICs as they would for direct employees.” The paper also asked for views on whether the tests to determine if IR35 applies could be simplified, “such as requiring an engagement to last a certain minimum amount of time to be considered one of employment.”[8]  

In November 2015 there were reports that the Government was planning a change in these rules so that any contractor whose placement lasted more than a month would have to go onto the client’s payroll as their employee.  However, despite expectations, the Government did not announce major reforms to the rules at this time.

Several other measures have been introduced to prevent this corporate form being used for avoid tax. First, in the 2014 Budget the Coalition Government confirmed proposals to tackle the use of offshore intermediaries to avoid tax, and to prevent agencies based in the UK using contrived contracts to disguise employment as self-employment.[9] Second, in November 2015 the current Government announced that from April 2016 it would “restrict tax relief for travel and subsistence expenses for workers engaged through an employment intermediary” where the intermediaries legislation applied.[10] Finally, in the 2016 Budget Government proposed that from April 2017 public sector bodies would have new duty to ensure any contractors that they took on were complying with IR35.[11]  A consultation exercise was launched in May 2016, and in the 2016 Autumn Statement the Government confirmed it would proceed with this reform.[12]  Notably as part of this consultation the Government ruled out introducing a similar duty on the private sector, or having a new test for applying IR35 based on the length of the contractor’s contract.[13]

This note discusses these developments; a second note discusses the introduction of IR35 and its first years of operation.[14]

Notes : 

[1]     HM Treasury press notice 29/10 20 July 2010

[2]     OTS, Small business tax review, March 2011 pp5-6. The debate over merging tax and NICs is discussed in: National Insurance contributions: an introduction, Commons Briefing paper CBP4517, 21 December 2015.

[3]     Budget 2011, HC 836 March 2011 para 2.203. HMRC publish guidance on the IR35 rules on Gov.uk.

[4]     HC Deb 23 May 2012 cc1159-70; HC Deb 23 May 2012 cc67-8WS; HMRC, Consultation into the Taxation of Controlling Persons, 23 May 2012

[5]     Autumn Statement, Cm 8480, December 2012 para 2.103

[6]     Budget 2015, HC 264, July 2015 para 2.183

[7]     Intermediaries Legislation (IR35): discussion document, 17 July 2015 p10

[8]     op.cit. p8

[9]     Budget 2014, HC 1104, March 2014 paras 2.194-5

[10]    Autumn Statement, Cm 9162, November 2015 para 3.20; Budget 2016, HC901, March 2016 para 2.39.

[11]    Budget 2016, HC901 March 2016 p43; HMRC, Off-payroll working in the public sector, March 2016

[12]    Autumn Statement, Cm 9362, November 2016 para 4.11. Provision to this effect is included in the Finance Act 2017 (specifically section 6 and Schedule 1).

[13]    Off-payroll working in the public sector: reform of the intermediaries legislation, May 2016 pp36-8

[14]    Personal service companies : introduction of the IR35 rules, Commons Briefing Paper 914, 20 May 2011

Commons Briefing papers SN05976

Author: Antony Seely

Topics: National insurance, Taxation

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