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WHITE PAPER: Personal service companies |Consultation & Debate

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 report looks at recent debate on how these rules might be reformed and wider concerns about the use of employment intermediaries to avoid tax.

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.[7]

One question raised in the paper  was whether the onus for determining whether IR35 applied or not should be placed on the client, rather than, at present, the PSC itself: “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 that any contractor whose placement lasted more than a month would have to go onto the client’s payroll as their employee.[9]  However, despite expectations, the Government has given no further details of how it intends to take this forward.[10] It is worth underlining that the discussion document states, “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.”[11]

There have continued to be concerns over employment intermediaries facilitating the avoidance of employment taxes. 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.[12] The Coalition Government also raised concerns regarding the way in which workers engaged through an employment intermediary were claiming tax relief on travel and subsistence expenses. In July 2015 the current Government launched a consultation on this issue,[13] and in the Autumn Statement it confirmed that from 6 April 2016, tax relief on these expenses would “be restricted for individuals working through personal service companies where the intermediaries legislation applies.”[14]

This note discusses these developments; a second note discusses the introduction of IR35 and its first years of operation.[15]

Notes:
[1]     HM Treasury press notice 29/10 20 July 2010
[2]     Office of Tax Simplification, Small business tax review, March 2011 pp5-6
[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]Cm 8480, December 2012 para 2.103
[6]Budget 2015, HC 264, July 2015 para 2.183
[7]     Details are collated on Gov.uk.
[8]     HMRC, Intermediaries Legislation (IR35): discussion document, 17 July 2015 p8
[9]“Crackdown on personal service companies could raise £400m in tax”, Guardian, 6 November 2015; “Osborne to close tax loophole of staff being paid ‘off the books’”, Daily Mail, 6 November 2015
[10]    The issue has been raised several times in PQs: for example, PQ21182, 11  January 2016, PQ22025, 20 January 2016, and, PQ30179, 14 March 2016.
[11]Intermediaries Legislation (IR35): discussion document, 17 July 2015 p10
[12]Budget 2014, HC 1104, March 2014 paras 2.194-5
[13]Budget 2015, HC 264, July 2015 para 2.182
[14]Cm 9162, November 2015 para 3.20. see also, Budget 2016, HC901, March 2016 para 2.39.
[15]Personal service companies : introduction of the IR35 rules,

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