Letter To The Editor Of The Publication "Taxation"

Dear Sir

Robert Maas's article ("Alice in Primarololand", 17 August) draws attention to an important feature of the recent service company legislation. But his caricature of the Government's position is not helpful to taxpayers who will be affected by this legislation.

Like Robert, the Government don't think it is fair that people should pay tax twice on the same earnings, and the legislation contains a specific provision to prevent this from happening. It is designed to take account of the way people using service companies currently behave, and to keep the legislation as simple as possible.

The legislation provides for a comparison to be made, at the end of the tax year, between the amount of money received by an intermediary (usually a limited company) for work done under conditions which would meet the accepted definition of employment, less certain deductions, and the amount paid out to the worker within the year in a form subject to Schedule E tax. If the Schedule E payments and other benefits fall short of the amount received, PAYE tax and National Insurance must be paid on the difference on the last day of the tax year.

The reason for the shortfall may be because the money has been taken out during the year in the form of dividends rather than salary, or because it has been left in the company. In either case, because it is being taxed as a "deemed payment" at the end of the year, there needs to be a mechanism to ensure that it is not taxed (and subject to National Insurance Contributions) again.

Before this legislation, it was very unlikely that the situation Robert describes would have arisen: that a worker who had left money in her service company in this way would take it in a form subject to Schedule E tax and National Insurance Contributions in a subsequent year. It was much more efficient for tax and NICs purposes to take it as a dividend, and we understand that accountants generally advised service company workers to do so.

The legislation assumes that this practice is likely to continue. If money which has been taxed as a "deemed payment" is taken out as a dividend, either within the year in which the deemed payment is calculated or in a subsequent year, that dividend can be exempted from tax, and need not be declared on a self-assessment return. Because dividends are not subject to National Insurance Contributions, there is no question of a double liability to National Insurance Contributions.

If we had gone further, and provided a mechanism also to exempt some Schedule E payments (such as bonuses) in a subsequent year, it would have required much more complex legislation. The legislation provides for such payments to reduce the deemed payment for the year in which they are made, so it would have been necessary to distinguish between payments which were to be set against the deemed payment calculation in different years. It would also have been necessary to provide for exemptions from the operation of PAYE and National Insurance Contributions for some payments. I am sure that legislation this complex would have been criticised in your magazine and elsewhere.

So the legislation follows the current practice for service companies, in allowing them to take money out in the form of dividends without double taxation. We have no reason to expect that service company workers are likely to change their current practice and take out bonuses, after the end of the year, which could in some circumstances lead to a double tax charge. The different treatment of the various forms of payment will be made clear in further guidance on the calculation of the deemed payment, which we will issue around next April.

Yours faithfully

SARAH WALKER