The use of service companies has increased as a tax efficient method of individuals and their businesses providing their services.
This is very much due to
- the decrease in the number of large employers in the UK over recent decades;
- the movement in the UK economy to outsourcing services;
- employing individuals on zero hour contracts or flexible working arrangements; and
- the general growth in the SME market throughout all industries
A service company, as it states, is a company providing a specific service, quite often to a specific employer. For the owner-manager of the company, the advantage of using a company is that it enables you to draw income by alternate (and perhaps more tax efficient) methods.
Employees pay income tax and National Insurance Contributions, with their employers additionally being required to pay further National Insurance Contributions and pension contributions.
Alternatively, via a company, the individual may withdraw his/her income via a combination of salary, loans, expenses and dividend payments.
What is IR35?
IR35 was first introduce into legislation via the Finance Act 2000 and associated statutory instruments, commonly referring to the Inland Revenue press release no.35 issued on 9 March 1999 (“IR35”).
IR35 was introduced to combat tax avoidance strategies in a similar manner to the efforts taken to combat disguised remuneration, where individuals used an “intermediary” (most commonly a limited company) to provide their services where otherwise they would be an employee.
The detail is far more complex than this simple explanation and we would always recommend you seek advice on the implications of your company set-up.
- as a result, HMRC is able to examine the arrangement and apply conventional income tax and National Insurance Contribution rules to the payments received by the intermediary company where IR35 applies and the individual is considered to be employed via the intermediary;
- this has led to a number of company insolvencies in recent years and consequentially, with time, the directors of those companies may be liable personally for allowing the company to be set-up for this purpose, and effectively using tax receipts to continue trading and benefit themselves personally.
What is employment?
This is perhaps part of the greatest difficulty that HMRC faces when applying this rule. Some of the tests historically developed in case law to determine an employed status include whether tools of trade were supplied by the contractor or not (in the case of an employee).
Over the years wider tests were applied, including whether the company was required to only supply the person specified (or whether it could supply any contractor) and the degree of control that the contractor has, as opposed to someone effectively acting as an employee (who may have little or no control over their working environment).
Penalties under IR35
The penalties for an individual operating their own service company can be quite severe if they are later found to fall within IR35 without declaring it.
If found to fall within the IR35 regime without declaring the correct tax liability, a company could be liable
- to account for up to 25% more tax (than would be payable under the conventional PAYE/NIC payroll rules); and
- a penalty of up to 100% (in addition) dependant on the determination by HMRC as to how deliberate the concealment of these liabilities were.
Recent changes in the legislation have moved the burden to determine employment, and therefore any contravention of IR35, for contractors working in the public sector on to the public sector employer. This presumably simplifies the process a lot of arrangements, as it is determined centrally by government employers who merely account for it internally and provide less pay.
Insolvency and threat to directors
This can go back up to 20 years and could lead to the company facing a huge tax bill, insolvency and the director could be pursued personally for some or all of these losses, either by way of director disqualification proceedings, a compensation order or a claim for a breach of his/her fiduciary duties.
At Francis Wilks & Jones we are able to assist with any claims arising from HMRC, the Secretary of State or a liquidator in respect of these matters. Please call any member of our tax disputes team for your consultation. Let the experts help.