Contractors, are your dividends at risk of a ‘look through’ by HMRC?
Contractors are rightly concerned about what happens should agencies refuse to pay their limited companies next year due to private sector IR35 reform, writes former tax inspector Carolyn Walsh, managing director of CWC Solutions.
But if contractors close their companies will they remain at risk of HMRC retrospectively assessing their company income under IR35 legislation? That’s a really big concern for many.
'Little-known' -- for now
I have to say that advising that contractors should close their limited companies without an exit strategy is inadequate advice to the point of negligence and while IR35 defence products are available, they may actually prove useless given the way that HMRC approaches the issue. This is a subject that would take pages to cover but to summarise, my opinion on this stems from a little-known insertion which the Revenue made in its 2014 guidance, concerning the interaction of PSCs with the ‘Agency Legislation.’
“Genuine dividends from the PSC would not normally be considered to be remuneration for the purposes of the Agency Legislation. However in cases of avoidance there may be instances where HMRC argue that these payments are remuneration either as general earnings or as remuneration for the purposes of the Agency legislation.”
I’ve emboldened the relevant bit. This is a provision granting HMRC the power to ‘look through’ the dividends paid of any contractor involved in an avoidance enquiry. It means that, unlike salary payments which fall outside of the Agency Legislation, the part of the limited company’s income generated under an agency contract – that which was treated as dividends – is within HMRC’s scope for scrutiny.
HMRC's 'look through' of your dividends (cont.)
I have to say that from HMRC’s perspective, this is a waiting game and it’s probably being seen as a win-win, because by the time any enquiries arise, it can be assumed that agencies will have deemed contractors ‘inside IR35’ (based on the engager’s decision), under the Off Payroll Working rules.
It follows that if agency workers are working under Supervision, Direction or Control, which is what agencies are effectively saying when they uphold an IR35-caught determination, then it’s likely the Agency Legislation applied before IR35 is considered. It’s not a great stretch of the imagination to suggest the Revenue will then rely on its 2014 addition, permitting dividends paid to come under its remit.
And if the Revenue does look through your dividends, these payments can potentially then be reclassified by the taxman as remuneration, incurring a PAYE debt. This would have the same financial outcome as a win for HMRC under IR35. But with agencies effectively admitting ‘SDC’ applies, HMRC can, and I suspect will, use the Agency Legislation instead.
Contractors caught in the crossfire
So, if the worries about retrospective IR35 enquiries aren’t unsettling enough, contractors could find themselves caught in the crossfire between HMRC and agencies. Yet this isn’t all bad for the contractor, particularly for those of them whose agency made it a requirement of the contract for a PSC to be used.
Alright, agencies may shoot contractors in the foot by stating that agency contracts have been carried out under ‘Control,’ leaving contractors to argue against that point and needing to rely more heavily on other factors to prove their status was ‘outside IR35’all along. But as far as I can see, contractors could agree to disagree with HMRC on the issue of SDC, while being mindful that the Revenue already has a Targeted Anti Avoidance Rule in place to recover unpaid PAYE (on dividends if they are treated as general earnings), from the agency.
Exit (and other considerations)
With the right kind of exit strategy now, contractors could protect against future issues, but most IR35 products probably don’t go far enough, and may not be useful in the event of an enquiry where the contractor has worked entirely on agency contracts.
My advice, where contractors do decide to close their PSC as a result of losing agency managed contracts next year, is to be very aware of how the interaction of Agency Legislation with PSCs impacts your situation; keep as much evidence as you are able to, and be mindful of what HMRC asks in the event that an enquiry does happen.