Over the last few months I have become involved in a number of IR35 enquiries that have a common denominator – the contractors have attempted to close down their companies. Despite the fact that each of the freelancers remained IR35 compliant, they have all been concerned that should they be caught by IR35 then HMRC would look to them personally to satisfy the tax debt. This is because no assets remain within their companies to pay any potential IR35 liability.
In certain circumstances HMRC can recover tax from an employee which has not been deducted by the employer but this is limited. Regulation 72 Income Tax (PAYE) Regulations 2003 provides that such recovery can take place where:
Similar provisions for recovering NIC are contained within Regulation 86 Social Security (Contributions) Regulations 2001.
It is because IR35 is, to a certain degree, a subjective piece of legislation and riddled with areas of grey, that Regulation 72 could not be applied in situations where a contractor has fulfilled their IR35 obligations. HMRC would have to demonstrate that a freelancer knew full well their contracts fell within the intermediaries legislation yet, despite this, continued to ignore the fact and blatantly failed to deduct PAYE.
In the recent First Tier Tax Tribunal case of Prowse & Anor v HMRC, Mr & Mrs Prowse were directors of a company that was liquidated in October 2010, leaving unpaid PAYE liabilities, part of which related to amounts paid to the husband and wife. HMRC made determinations effectively shifting those liabilities from the company to Mr & Mrs Prowse.
The company’s business was that of shot blasting and industrial painting, mainly for the rail sector, and had been successful up until June 2010 when it encountered unforeseen circumstance and simply ran out of money.
Mr & Mrs Prowse had always taken small salaries and large dividends but that policy changed in 2009 when the directors decided to receive higher salaries for the sake of convenience.
The Prowse’s knew the net amounts they needed each month and instructed an unconnected third party payroll operator to compute the gross figures. However, whilst the PAYE had been correctly calculated the tax and NIC was not paid over to HMRC because of cash flow problems.
HMRC contended that the decision to alter the method of profit extraction from dividends to salary was made when the likelihood of insolvency had been realised and thus no dividend could be paid. The Tribunal however rejected this as the evidence showed that the decision had been taken in January 2009 when the company was financially buoyant.
The Revenue also argued that the payroll records were manufactured retrospectively but the Tribunal disagreed, finding that the records were maintained and delivered on a regular basis.
A further argument put forward by HMRC was that the payslips presented a false picture of the actual amounts made to the directors and there was insufficient evidence to demonstrate that the company had deducted the right amount of tax. The Tribunal however accepted that a reconciliation of the payments would have taken place at the year end had it not been for the fact that this had been overshadowed by the liquidation of the company.
In conclusion, the Tribunal were satisfied that the directors had had PAYE correctly applied to their payments and therefore found in favour of the taxpayers.