Taxman clarifies service company question

HMRC has spelt out how service companies can assess their liability to the IR35 and MSC tax laws, seeming to head off renewed attacks its demand on P35s is ambiguous.

Last year, advisors blasted the two-part probe, number 6 on the form, which asks whether the employer is a service company, and, if so, whether it operates the tax rules.

At the time, legal experts derided the first part as "meaningless", saying 'service company' lacked a statutory definition and had no fixed make-up in the marketplace.

Now, however, the Revenue has used the E10 Handbook to make clear that 'service company' "includes a limited company, limited liability partnership or a partnership."

It said its first curiosity – 'Are you a service company?' – was intended to 'narrow those employers who need to consider whether the second question applies.'

Both officials and industry experts agree that answering 'no' to the question in this part automatically dictates the answer to the second question is also 'no.'

HMRC said employers should answer 'yes,' they are a 'service company,' if:

-an individual performed services (intellectual, manual or a mixture of the two) for a client or clients, and

- the services were provided under a contract between the client and the company of which, at any time during the tax year, the individual performing the services was a shareholder or partner, 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 the services performed by the shareholders or partners personally.

HMRC added 'yes' was also the answer for absolutely all service companies, not just IR35 entities and MSCs, with its officials said to interpret "personally" to mean 'in person.'

The Institute of Chartered Accountants in England and Wales reflected: "We think that many small employers who provide intellectual and manual services to clients are likely to come within the 'service company' definition in leaflet E10 and should answer 'Yes' to this part of the question."

The Revenue's second curiosity, whether the IR35 and MSC laws have been applied, should be answered 'yes' if income has been treated as deemed employment income under the respective rules.

In the E10 handbook, HMRC added a 'yes' was also the right answer where an engagement was within IR35, but the deemed payment was nil because sufficient employment income had been paid.

"Employers who answer 'Yes' to the first part of Q6 will not necessarily answer 'Yes' to the second part as they may not be within IR35 or an MSC," the ICAEW said. "It is likely that many forms P35 will show a 'Yes'/'No' combination."

HMRC has denied the exercise is to help it risk profile employers, and observers say such a programme would be too resource intensive for the department to manage effectively.

However, the taxman has said that, broadly, a 'yes'-'no' answer "indicates a business which falls within the general ambit of Chapter 8 or 9 ITEPA but which has not treated any income as deemed employment income."

Employers responding 'yes'-'no' will view HMRC's stance as another reason why it may benefit them to ensure their company's contractual and working arrangements stay outside the scope of the MSC and IR35 legislations.