Trawling Tax Returns for IR35

It may be too early for many contractors to contemplate the completion of their 2012 self assessment tax return but when they do knuckle down to the task they will need to consider the Service Companies section on TR4 of the main tax return.

The Service Companies section invites individuals to complete it, 'If you provided your services through a service company (a company which provides your personal services to third parties), enter the total of the dividends (including the tax credit) and salary (before tax was taken off) you withdrew from the company in the tax year.' To assist taxpayers in deciding whether or not they should fill in this part of their return, page TRG 21 of the tax return guide defines a service company as being where:

  • an individual performed 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 the individual was, 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 (that is, more than half of it) from services performed by the shareholders personally.

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

HMRC recently admitted that the P35 service company question had no statutory basis and those that ignored the question therefore had legitimate grounds for doing so. Can the tax return request be ignored on the same basis or does its inclusion on the personal tax return give it a statutory basis, compelling individuals to complete it, where appropriate? Keith Gordon, tax barrister at Atlas Chambers, believes that the service companies question can safely be ignored as it has no statutory backing and taxpayers cannot be penalised for failing or refusing to answer it.

The statutory basis for a personal tax return is restricted to that information that enables a person’s tax liability to be calculated for a tax year. As dividend and employment income are declared elsewhere on the tax return thus enabling the tax calculation to be computed, the service company section is therefore superfluous to requirements. Its sole purpose can only be to assist HMRC in their IR35 risk assessment.

So if a contractor chooses to ignore the box completely are there any ramifications? It would not be possible for HMRC to impose a penalty for an inaccurate return because penalties are levied by reference to the difference between the correct amount of tax and the declared liability, which the service company question would have no bearing on.

Since the question first appeared on tax returns in 2008, Keith Gordon has always included a note on the 'white space' informing HMRC that he refused to answer the question on the basis that it does not need to be answered and has never had his return rejected as incomplete.

Given the recent revised approach to the administration of IR35 and the formation of three specialist teams, could ignoring the question arouse HMRC's suspicions that a freelancer is trying to put the Revenue off the IR35 scent? As the service company box is only one source of information available to HMRC it would seem improbable that ignoring the question on its own would lead to the raising of a contractor’s IR35 risk profile.

To answer or not to answer the service company question would appear therefore to be a matter of personal choice. Let your conscience guide you!

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