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Senior individuals using personal service companies to have income tax and national insurance deducted at source, the Government proposes

Out-Law News | 28 May 2012 | 10:37 am | 4 min. read

Senior individuals who are 'controlling persons' will have income tax and national insurance deducted at source even if they contract through a personal services company, if a proposal, announced by HM Revenue & Customs (HMRC) and the Treasury in a consultation document, becomes law.

"It is the Government’s view that where an individual has the requisite level of control to direct the activities of the organisation and they are engaged at a senior level (through an intermediary) then that individual should be taxed as an employee" says the consultation document.

The consultation document suggests a change in law so that where an organisation engages a controlling person through an intermediary, such as a personal service company, the engaging organisation will be required to deduct the income tax and national insurance at source, as they would for their employees.

It is proposed that 'controlling person' will be defined as "someone who is able to shape the direction of the organisation having authority or responsibility for directing or controlling the major activities of the engaging organisation during the year". The consultation document goes on to say that this would be "someone who has managerial control over a significant proportion of the organisation’s employees and/or control over a significant proportion of the budget of the organisation."

Chris Thomas, a tax law expert at Pinsent Masons (the law firm behind Out-Law), commented that “the legislation is perhaps unsurprising in the context of the recent furore over ‘off payroll’ remuneration in the public sector. However, it will nonetheless be unwelcome news for many corporates who have, until now, been able to offer the benefits of gross payment without taking on any risk themselves.”

Thomas added that the Government’s thinking on the issue did not appear very well developed and that the consultation left a lot of questions unanswered. “The key will be how exactly they define who is a ‘controlling person’”, he said. “At the moment, the description is rather vague and it is likely to cause problems for businesses in determining who exactly is caught. Also it is not clear whether it will actually hit the intended targets. For example, non-executive directors are presumably in the Government’s sights, but it is by no means clear that they would be ‘able to shape the direction of the organisation’. We will also need to see how the regime applies where a controlling person is supplying separate consultancy services – although one would hope that this should not be affected”

Rules currently exist, commonly known as IR35, to prevent tax avoidance using personal service companies. The IR35 rules apply where the relationship between the end client and the worker would be one of employment if it was not for the interposition of an intermediary, such as a personal service company.

A worker caught by the IR35 rules can take out of the personal service company as salary the money earned from that contract and pay tax and National Insurance on those salary payments in the normal way. However, to the extent that the worker does not choose to pay the money out as a salary, at the end of the year, the personal service company is required to calculate a deemed payment on which employee national insurance contributions and income tax are due and a deemed employer national insurance payment.

The Government considers that IR35 is not sufficient to solve for the senior workers the new rules are aimed at.. "When IR35 was introduced 10 years ago it was comparatively unusual for controlling persons of an engaging organisation to be working through a PSC [personal service company]. In the last few years anecdotal evidence suggests that it has become an increasingly common practice in both the private and public sectors." states the document.

It explains that because the IR35 legislation places the obligation on the personal service company to operate income tax and national insurance "this means that even where the appropriate tax and National Insurance for the circumstances of the case is being paid, that is not going to be clear and transparent to the engaging organisation."

The Government believes that, "because of their role in an organisation, controlling persons should be required to meet their income tax and National Insurance obligations in a way which is transparent to their engager. This is not currently possible where they work through a PSC" states the consultation document.

'Micro businesses’ who engage controlling persons through a personal service company will be excluded from the new rules. A micro business, is defined by the EU as a business which employs fewer than 10 persons and whose turnover and or balance sheet does not exceed €2million (approximately £1.7million.)

In a parallel development, new tighter rules governing ‘off payroll’ appointments in central government will be brought in this September.  This comes after a review of Government departments and their arm’s length bodies revealed that over 2,400 key public sector appointees have been engaged off payroll, in some cases for more than ten years. 

The review was commissioned by Chief Secretary to the Treasury Danny Alexander earlier this year.  Each of the departments and bodies involved has published on their websites a list of off payroll appointees who were engaged at an annual cost to the department of more than £58,200.

Engaging a worker through a personal service company can be attractive for both the engager and the worker. The engager can save employer's national insurance contributions (currently 13.8%). The engager also has no requirement for the engager to provide other benefits such as holiday pay, sick pay and pension contributions.

Working through a personal service company can enable a worker to withdraw the profits in a tax efficient way, saving national insurance contributions and income deductions under PAYE and also with more generous expense tax deductions.