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Contractors Ignoring Service Company Question

HMRC reveals apathy towards tax return question

During the final session of hearing oral evidence the House of Lords Select Committee on PSC’s were told by HMRC that in 2011/12 only 1,000 contractors answered the ‘service company’ question on the Self Assessment Tax Return. This left around 199,000 freelancers that ignored the question!

Over two sessions officials from HMRC were recalled to give evidence, along with senior figures from industry:

First session:

  • Jim McInally – Human Resources Director, Reward & Pensions, BT;
  • Bill Louv – Senior Vice President of Core Business Services, GlaxoSmithKline (GSK); and
  • Mark Fell – Legal Services Director, Crossrail.

Second session (HMRC officials):

  • Rowena Fletcher, Deputy Director with special responsibility for the Employment Status Team;
  • Robin Wythes, Team Leader of the Employment Status Team; and
  • Peter Lumb, member of the Direct Business Tax team.

The Lords’ questioning of HMRC opened up by seeking to establish the reason why they had amended the Exchequer risk figure for IR35. In November 2013 Rowena Fletcher had told the Committee that this was £475 million but was then subsequently amended upwards to £550 million last month, a difference of £75 million! A rather timid Peter Lumb explained this was due to costing principles that were calculated on best available evidence. The original £475 million was based on data going back to 2008/09 that was used to produce the Office of Tax Simplification’s report in 2011. This costing was then refreshed using data from 2010/11.

Lumb then went on to explain the assumptions behind the figures:

£30 million from those making deemed payments

A total 6,000 contractors had indicated that their engagements were caught by IR35.

£115 million from revenue protection

Some 220,000 directors take 50% of their remuneration as dividends. According to Robin Wythes IR35 dissuades these directors from pursuing a more aggressive dividend strategy.

£405 million from dissuading contractors moving into PSC’s

If IR35 were removed then a number of freelancers would form their own companies who, at present, are employed by Umbrella companies and the like because of IR35.

The P35 and tax return service company question

In 2011/12, 120,000 contractors indicated they were a service company via form P35 compared to only 1,000 Self Assessment Tax Return entries responding to the corresponding question. Given that HMRC estimate there are 200,000 PSC’s, then 99.5% of all freelancers appear to be choosing to ignore the tax return question. Wythes attributed this extremely low figure to ignorance and a conscious decision on the part of freelancers not to complete the section on the tax return.

Whilst the tax return question is only an IR35 risk indicator and not an automatic trigger to start an enquiry, Wythes confirmed something that the writer has long believed, that ignoring the question is a factor in HMRC’s risk profiling.

Do HMRC keep a track on the number of PSC’s?

The Revenue do not seek to regularly monitor how many PSC’s exist as it does not enhance their understanding of the underlying tax risk. They do however use analysis of the labour market to better understand the use of intermediaries and where they are being used.

What is the cost of IR35 enforcement?

HMRC currently employ 40 people across 4 specialist IR35 teams to police IR35. Whilst no statistics exist as to how much this costs, Rowena Fletcher estimated this to be £700,000 per annum. Whilst this was a very rough figure it does appear to be rather low. Nevertheless, did HMRC believe expending £700,000 to bring in £1.1 million additional revenue in the last tax year a good return? Fletcher explained that the yield of the IR35 teams should not be evaluated to the work that they do and that the department do not allocate costs against specific pieces of tax legislation. Furthermore, raising tax yield is only part of the teams work as the teams also help to manage future risk.

Why do so few IR35 enquiries end up at Tribunal?

Wythes stated that since its introduction there have only been 25 IR35 cases that have ended up before the tribunals and courts, with 12 being found in favour of the taxpayer and 13 for HMRC. There have been no tribunal hearings involving IR35 since 2011 but there are 5 appeals waiting to be heard.

Any IR35 case that HMRC decide to take to tribunal has to be in accordance with their litigation strategy and potential tax yield will not always be the motivator behind such a decision. Sometimes there are fundamental principles at stake, e.g Dragonfly Consultancy Ltd (2008) where the High Court upheld certain employment status principles.

Low paid workers

HMRC are seeing more cases of lower paid workers operating through PSC’s and the department needs to understand if these people are being forced down this route as part of mass market tax avoidance. To date, they have seen no evidence of this but if this is the case then it is likely that the Managed Service Company (MSC) legislation will be used to combat such avoidance.

Umbrella companies

Wythes confirmed that HMRC are aware of abuse of expenses within Umbrella companies and therefore the PAYE risk lies with the Umbrella. Should the Umbrella company default in paying over any additional tax as a result of being found guilty of such practice then HMRC would seek recovery from the directors of the Umbrella.

The Committee will now make its recommendations in due course.

By Andy Vessey

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5 thoughts on “Contractors Ignoring Service Company Question”

  1. James Longworth

    £700K between 40 staff!

    Does anyone believe that HMRCs specialist staff work for £17500 even if that figure is cleverly allowing for the return into HMRC of their NI & PAYE?

  2. Graham

    So £115m saved from 220,000 directors, £415m from people working through umbrellas and HMRC reckon there are 200,000 PSCs. Even following basic maths I can’t be the only person who thinks these numbers don’t make sense.

  3. Tony

    “So £115m saved from 220,000 directors, £415m from people working through umbrellas and HMRC reckon there are 200,000 PSCs. Even following basic maths I can’t be the only person who thinks these numbers don’t make sense.”

    This struck me as absurd too. PSCs are by definition one man bands. Yet 110% of them comprise of directors taking no more than 50% dividends? Anecdotally, this makes no sense, and I imagine this either refers to a subset of all directors, or is a flawed figure. Maybe an extra 0 in there.

    Is the Committee done now?

  4. Tony

    Also, at certain day rates taking more than 50% dividends may simply not make tax sense, since you’re paying more tax on them, so is it surprising that many directors opt to instead take these amounts e.g. in a pension?

  5. Tony

    This explains the numbers:

    http://www.contractoruk.com/news/0011422hmrc_reveals_psc_dividends_be_more_just_monitored.html

    HMRC is ballparking and guesstimating, methinks, to avoid looking stupider in the Lords’ eyes than they already do since Fletcher’s “minor” hickup.

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