Inland Revenue Comments On Institute Of Chartered Accountants Publication "Towards A Better Tax System"
Extract from a letter from the Inland Revenue to the Institute of Chartered Accountants
Perhaps I could also take the opportunity of this letter to make a few comments on the critique of the service company legislation in the Institute's publication "Towards a better tax system". As you would expect, I was disappointed at the verdict, particularly in view of the changes which were made to the policy in September to meet most of the Institute's original criticisms. I was particularly surprised at the repeated suggestion that the Government's policy intention was not clear, when the use of service companies to avoid tax and NIC has been well known to the accountancy profession for years.
There are a number of points in the booklet which are not correct, and I hope you will find an opportunity to correct them. Most importantly, it says that the Revenue have taken the view that if the worker is acting through an agency, he or she will be treated as an employee whatever the contract says. The advice we have given relates only to the standard agency contract which was (and still is) common in the IT industry. We have said that where there are engagements of more than a month on these terms, which specify a set number of hours per week, on the client's premises, for an agreed hourly rate; require the worker to act under the control of the client's staff; and do not allow substitution, our opinion is likely to be that they meet the definition of employment.
It is suggested that there are problems with the interaction between this legislation and the construction industry scheme. In fact the two are independent. Where the Service Company has a contract to which the Construction Industry Scheme applies and that company has not qualified for a gross payment certificate the scheme provides for a deduction on account of tax to be made from the payment to the subcontracting company. That deduction is made on account of any liability to corporation tax that the company may have in the future. The service company legislation, on the other hand, deals with the PAYE and NIC position of a worker who meets the definition of an employee. It is not inconsistent to apply different expenses rules to a company and to an individual: indeed that will continue to be the case for all companies affected by the new legislation. It has never been possible to offset CIS deductions made under a contract between a client and a subcontracting company against the PAYE deductions of the directors of the company. Nothing in this legislation changes that relationship or the legal person to whom the deductions belong.
The booklet suggests that the application of the agency rules in partnership cases could result in a situation where both the agency and the partnership had to operate PAYE on the same amount. This is not true. Any payment by an agency directly to an individual partner on which Schedule E tax is payable is specifically excluded from the calculation of the deemed payment (see Step Two of Paragraph 7 of Schedule 12). Where the payment to the partnership is caught by the agency rules then a deduction will be given at Step Seven in the deemed payment calculation.
It also suggests that both the client and the intermediary could be liable to operate PAYE on the same amount, where the intermediary is based overseas. This is not true either. Section 203C, which places the obligation to operate PAYE on the "host" of an employee of an overseas employer, only applies in cases where the PAYE Regulations do not apply to the employer. Schedule 12 (paragraph 11(6)) brings the employer within the scope of the PAYE regulations, so 203C cannot be applied in respect of the deemed payment.
The booklet is critical of the provision which it claims imposes joint and several liability on unconnected intermediaries involved in a contract. But contrary to what the booklet says this only applies to intermediaries connected with the worker (see paragraph 14(2) of Schedule 12).
It is suggested that the arrangements we have announced to allow for difficulties in calculating the correct amount of the deemed payment in time to account for PAYE on 19 April will require agents to do the work of calculating the tax and NICs twice. In fact we have made it clear that we will accept any amount on account on 19 April, as long as the Form P35 indicates that a deemed payment under the service company rules is due. This need not require a detailed calculation. No penalties will be charged if the amount is corrected by the following 31 January. And as I have already mentioned, if regular payments of salary are made during the year, the deemed payment itself should be a relatively small amount.
I do not agree with the assertion that the rules are poorly targeted. They only affect people who would be employees but for the existence of intermediaries, using the accepted D/E borderline test. And their effect is limited to situations where the worker is able to use an intermediary under his control to manipulate the form of his income, by exceptions for larger companies and partnerships which cannot be used in this way. The latter was, as you know, a response to representations from the Institute and other representative bodies.
The booklet suggests that the partnership rules can easily be avoided. I would be very interested to hear how you think this can be done.
Finally, the booklet criticises the apparent lack of a right of appeal where income from a contract is apportioned between two workers, or where an inspector grants relief of tax on distributions to prevent double taxation. But in either case an appeal will be possible, in the former case against a determination under Regulation 49 of the PAYE Regulations and in the latter on a Revenue amendment to the self-assessment of the recipient of the dividend.
It would no doubt be helpful to the Institute's members and other readers of the booklet if the factual inaccuracies I have pointed out could be corrected.
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