Tax Return: Fishing for IR35

It is likely that there are still a number of contractors who still haven't filed their 2011 self assessment tax returns and are pondering whether or not they are obliged to complete the 'Service Companies' question contained within the return. Some may argue that their business does not fall within the definition of a service company, whilst others may just choose to ignore the question on the basis that they cannot be penalised for doing so.

What does the tax return guide say?

The 2011 tax return guide states that you should complete the box if you provided your services through a service company where:

• you performed your services (intellectual, manual or a mixture of both) for a client (or clients), and
• the services were provided under a contract between the client(s) and a company of which you were, at any time during the tax year, a shareholder, and
• the company's income was, at any time during the tax year, derived wholly or mainly (ie more than half of it) from services performed by the shareholders personally.

The box does not need to be completed if all the income derived from the company was employment income.

It is difficult to argue against the above definition where a personal service company comprises of one person who is the sole director and a shareholder and who generates the vast majority, if not all, of the company's turnover.

Ignoring the box

Some freelancers are concerned that by filling in the box will immediately draw HMRC's attention to the fact that IR35 may be an issue and result in an impending IR35 enquiry. Certainly the only purpose of including this section is for HMRC's convenience in collecting IR35 intelligence and risk assessment but the fact is that the Revenue have many other sources of information at their disposal to aid them. For instance, form P35, the corporation tax return and company accounts, are all sources of information that provide HMRC with sufficient information to decide whether or not a company is an IR35 risk worth scrutiny.

The information that has to be entered in the 'Service companies' box is the total of the gross dividends and salary extracted from the contractors' company in the year ended 5th April 2011. This, however, is a duplication of figures that will have already been reported elsewhere in the tax return that help to calculate an individual's tax liability for 2010/11. Thus, by ignoring the box will not give rise to any loss of tax and therefore, as penalties for inaccurate returns are tax geared then such a penalty cannot be imposed.

At the IR35 Forum of 14th September 2011, HMRC confirmed that the service company question is, in many cases, left blank which itself can be risk profiled against other entries on the return which would tend to indicate that the question should have been answered. So those that believe by abstaining from answering the question may be helping them to keep their heads below the parapet, quite the reverse could be true.