IR35 experts clash over new service company question

A declaration by the taxman that he will streamline a two-part probe into whether contractors are service companies and, if so, liable to the IR35/MSC rules is dividing advisors – yet they all agree his IR35 business test needs correcting.

Shown the minutes for July’s IR35 Forum meeting – the first since the business entity test went live, the advisors told ContractorUK that the biggest development for contractors was the merger of question 6 on the P35 form.

Currently, it asks contractors - Are you a Service Company? If Yes, have you operated IR35 or the Managed Service Companies legislation?’, absent of a definition from HMRC in the form’s guidance note of what a service company actually is.

Although criteria are available from the Revenue, the IR35 Forum heard that, in future, question 6 will state, ‘Are you a service company who has operated the Intermediaries legislation (sometimes known as IR35) or the Managed Service Companies legislation?’

Moreover, this updated question will be embedded into the PAYE regulations for 2013/14, the forum minutes show, meaning it will “become a legal requirement” for contractors “to answer it on the last return for the tax year.”

Mandating the question could be the taxman’s response to some IR35 advisors who have told contractors that they are under no obligation to answer it, nor would they face penalties for leaving it blank, consultants at Accountax have said.

The Revenue’s motive for the change is not recorded in the forum minutes, yet IR35 advisory Contractor Essentials expects most limited company owners to regard the question’s rephrasing (and its enshrining in law) as a “vast improvement.”

Founder Elaine Hazelwood explained: “A contractor now only has to answer ‘yes’ if they are a service company that has operated IR35, so any contractor who has taken advice that IR35 does not apply to them can answer ‘no’. 

“At present, many businesses, including non-contractor businesses, actually fall into the service company [criteria] but are not within IR35, so they find themselves answering ‘yes’ to the first question and ‘no’ to the second, which has led to a great deal of confusion.”

Martyn Valentine, of legal and IR35 specialists The Law Place, is less convinced that the redrafting of P35  question 6 will be welcomed, believing that the Revenue has effectively replaced confusion with more confusion.

“The new question six is bizarre and is likely to cause confusion for limited company contractors. After all, it is possible for a limited company contractor who retains full control over the operation of the company, and is therefore not a Managed Service Company, to [still] be caught by the IR35 legislation.

“This rephrasing seems to be have been founded on a misunderstanding of both sets of legislation,” he said, “and requires complete redrafting before being inflicted upon the statute book.”

The legal expert points out that, compared with the MSC rules, a limited company contractor is “better off” being caught by IR35, because the legislation provides for a 5% reduction in liability to allow for expenses in running a company.

“By contrast, the Managed Service Companies legislation calculates tax liability at source with no allowance for running a company,” Mr Valentine said. “As it stands, the change to question six is dangerous and misleading for limited company contractors.”

Although they were speaking to CUK independently of each other, both IR35 experts agreed about the IR35 business entity test – in terms of its duration and success - which, despite reports to the contrary, is still under a fixed 12-month pilot.

The mere “suggestion,” the forum minutes state, by one member that the point-allocation regime around the 12 questions that make up the test should not be changed for “around 2 years” is just that – a suggestion.

Ms Hazelwood reflected: “Paragraph 15 [of the minutes] appears to [record] an attendee suggesting that the weighting given to the various business tests shouldn’t be changed for two years or so, rather than HMRC stating that this would be the case. So I don’t believe that this is HMRC giving a steer that the tests could be with us long term.”

Similarly, The Law Place says any extension of the IR35 business test from one year to two years “only seems to be a proposal from a single forum member at this stage.”

Mr Valentine added: “The facts remain that the business test does not alter the current legal position or add to the crucial question of mutuality of obligations. For those reasons alone, the current business tests need to be amended”.

Contractor Essentials has already spelt out how the business test bears little correlation to the realities of PSC working and, earlier this month, the Recruitment & Employment Confederation said that HMRC does indeed need to think again.

“The new tests aren’t perfect and we would like to see their calibration revisited”, said the REC’s policy head Gillian Econopouly, who was present at the IR35 forum’s July meeting.

Meanwhile, the minutes confirm predictions to CUK that HMRC’s new IR35 guidance, alongside the business test and IR35 scenarios, has allowed a more “focussed approach” from its three compliance teams which, in turn, has led to more contractors coming under review.

The minutes add: “HMRC also reported an improved turnaround timeline of cases and gave an example where a review had been concluded within a period of six weeks.”

In line with the REC, Valentine said that, “on the face of it”, quicker review times are “encouraging,” though Hazelwood reminds that the six-week timeframe applies to a single review; “there is no indication of how long the average IR35 review takes,” she said.

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Written by Simon Moore

Simon writes impartial news and engaging features for the contractor industry, covering, IR35, the loan charge and general tax and legislation.
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