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Lords PSC (1): HMRC gives evidence on personal service companies
by Susie Hughes at 16:08 04/12/13 (Political News)
The evidence gathering sessions of the new House of Lords Committee into 'personal service companies' kicked off with the views of two senior civil servants from HM Revenue and Customs.
Rowena Fletcher, Deputy Director with overall responsibility for compliance and employment status, and Robin Wythes, Team Leader of the Employment Status Team in personal tax, were the first witnesses to appear before the Committee, whose brief is 'to consider the consequences of the use of Personal Service Companies for tax collection'.

The Committee will be gathering evidence on a number of issues involving Personal Service Companies (PSCs), including their use, compliance activies, the effectiveness of the current IR35 regime and the role of umbrella companies.

However, this should be put in the context that, as Mrs Fletcher admitted in her opening remarks, there is no statutory definition of a personal service company, which was simply a term coined in 2000 to identify those companies intended to be targeted by IR35.

The key points to emerge were:
HMRC estimated there are around 200,000 PSCs in the country, up from about 90,000 in 1999 when IR35 was introduced, although this figure cannot be held to be strictly accurate, more to reflect trends. The increase reflects the changing dynamics of the labour market and the existence of a personal service company in itself is not an indicator of risk of non-compliance.

HMRC has long been criticised for not knowing detailed statistics on the penetration and effectiveness of IR35. Mrs Fletcher again confirmed the lack of information and explained that as IR35 works on a contract by contract basis, there is not necessarily a correlation between the number of PSC where IR35 might apply. HMRC wants to target its activities towards the companies where all their contracts fall within IR35, ie where the relationship with the client is effectively an employment relationship.

When pressed on precise numbers, Ms Fletcher was unable to give details, however she felt that the overall Exchequer risk now is still broadly in line with the original Exchequer risk, in the region of 475 million, which was estimated when the legislation was introduced.

This risk is made up from the Exchequer yield from people who operate IR35 - the larger part the deterrent risk The latter includes those who, if it were not for IR35, would otherwise operate through a personal service company and those people who are paying themselves above the level of personal tax allowances, whereas without IR35 they might adopt 'a more aggressive remuneration strategy.'

There was some discussion about the introduction of the business entity tests in April 2012 and the impact they have had on investigations. Mr Wythes confirmed that in 2012-13, HMRC have opened up 256 new inquiries into cases where they believe that IR35 represented a high risk and tn the current tax year there have been 112 new cases in the first six months - a similar number to the previous four years.

They were considered high risk, ie where all contracts are considered inside IR35. (This represents a sizeable percentage increase in new cases from recent years - there were less than 120 investigations started from 2008 to 2012 : See - IR35 investigations double and tax yield up five times - Shout99, Oct 12). This increased activity is planned to continue.

There are currently 40 staff deployed to this area for compliance, together with their managers plus support staff and while they look at risk across the spectrum, the resource is targeted where it is most effective in terms of tax yield and deterrent. HMRC also targets across the sectors so no one group considers itself exempt.

Mr Wythes confirmed that opening an IR35 investigation is the beginning of a wider investigation into a company's operations and HMRC wold also look at business expenses, which they believe is also a wide area of abuse. Travel and subsistence was cited as a particular example.

It was also revealed that the time taken to conduct an investigation has reduced significantly from over two years, to an average of six months from opening to closing cases in 2012-13 (although this tends to be when there is no further action required. The reduction in time scale is in part due to the four specialist compliance teams which have replaced the generalist teams. Also, HMRC has taken action to close cases quicker when they have decided that IR35 does not apply.

Reasons for incorporation
There was considerable dialogue about the reasons for incorporation versus self employment employment or partnership arrangements. While it was accepted that there are multiple drivers for incorporation, Mr Wythes also said that some people are incorporating for tax-motivated reasons on the basis that the current tax structure allows an individual who has incorporated to withdraw income in the form of dividends as opposed to earned income, be that self-employment income or employment income.

HMRC saw its role as trying to differentiate between those who incorporate for bona fide reasons and those who incorporate for tax-motivated reasons, and then to ensure that where the latter applies, 'to apply the law as Parliament intended'.

Understanding of IR35
Recent discussions in the IR35 Forum have centred on the need for improved education about IR35, which was also one of the topics raised by the Select Committee. Mrs Fletcher felt understanding has increased, as people have got used to IR35. However, there are moves to improve people's understanding of the issue, with the IR35 helpline, the contract review service, and technical specialists who are working on revised guidance, which will be more accessible. They are also looking at other ways to make information about IR35 more easily available.

It transpired that the IR35 helpline had received 1,200 phone calls and 80 contract reviews requested in the year to April 2012 and it was manned by three full-time people, who also provided the contract review service.

HMRC is looking at why the contract review service isn't used more and, accepted that not everyone might believe its is confidential.

When questioned, Mrs Fletcher said that, out of 60,000 employee, HMRC 'employed' one through a personal service company. Mr Wyhtes added that this was an occupational psychologist who earned over 58,200, and he clarified that there were a further seven individuals, all occupational psychologists earning under that amount, who were similarly engaged through personal service companies.

Business entity tests
The business entity tests which were introduced via the IR35 Forum in April 2012 have been the subject of much criticism as people incorrectly used them as status tests, whereas their intention is to identify risk of an investigation.

They are currently being re-examined as part of a review of all the processes to see if they are fit for purpose or whether they could be improved to be more useful.

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Susie Hughes Shout99 2013

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