Plumbers, IT contractors and senior interim managers all use service companies, but what does this mean for the collection of UK tax?

The House of Lords has published its report on Personal Service Companies. Unsurprisingly, the report finds that the employed/self employed tax divide and the tax paid on earned income as opposed to unearned income are key to many of the problems, while IR35 is an administrative nightmare and is fraught with uncertainty.

In November 2013, a Select Committee on Personal Service Companies was appointed by the House of Lords with the orders of reference ‘to consider the consequences of the use of personal service companies for tax collection.’ The committee was chaired by Baroness Noakes a former ICAEW President. Anita Monteith, Tax Manager with ICAEW’s Tax Faculty, was appointed as Specialist Adviser to the committee.

The committee noted that the use of personal service companies has expanded significantly and comments on some of the reasons why this might be. While the motivation to incorporate is not driven solely by financial incentives, the opportunity to make tax and National Insurance savings could not be ignored.

Inevitably, IR35 came in for considerable criticism.

‘The provisions are complex, and rely on contract-by-contract assessment and a sound understanding of case law to prevent abuse. This has driven the growth of a significant industry of professional advisers and accountants.

‘Some witnesses called for the suspension or abolition of IR35. Her Majesty’s Revenue and Customs (HMRC) told us that such a measure would put £550 million of revenue at risk. This figure is an estimate and was not, in our view, directly substantiated by any publicly available information. Given that the justification for maintaining the IR35 provisions relies almost entirely upon this calculation of a deterrent effect, we believe that HMRC should publish a detailed assessment to justify maintaining the IR35 legislation.’

It became clear to the committee that HMRC’s figures for the cost of administering IR35 were mere estimates and that the tax and NIC which could be at risk if IR35 did not exist, although estimated as £550m was also difficult to quantify.

HMRC’s Business Entity Tests also came in for criticism, and the committee felt these could be improved to provide greater certainty to taxpayers.

It is also surprising to learn that the committee was rather puzzled by HMRC’s responses to questions about how many individuals and employers answered the questions about service companies on the SA tax return (1,000 individuals) and on their year end PAYE reports (120,000 employers). The lack of correlation was rather large.

Recommendations of the committee include:

  • More work on the Government’s guidance on off-payroll engagements in the public sector.
  • Measures to build awareness of the potential negative implications of working through a company amongst the lower paid, particularly the absence of employment rights and entitlements, inadequate pension provision and exposure to potential HMRC compliance investigations.

It has also recommended that the Low Pay Commission should conduct a wider review of the use of companies by lower-paid workers, and the implications for pay, employment rights and statutory entitlements.

Longer term, the committee would like to see the case for combining taxes on income and National Insurance reviewed once more. The committee did recognise the complexities of this and the effect that this could have on the contributory principle, but it felt:

‘The current structure and rates of income tax and National Insurance provide an incentive for taxpayers to arrange their financial affairs in order to minimise the amount of tax and National Insurance paid. This has led to complex legislation, such as IR35, to counter such arrangements.’

It seems clear that this is an area which will continue to cause concern, but with so much tax at stake, finding a solution is not going to be easy.

Please contact Clearways Accountants on 01737 244298, or through the contact form below,  if you would like help in understanding IR35 or with setting up your own personal service company.