In its budget yesterday, the Government committed to introducing a package of measures "to tackle [tax] avoidance through use of personal service companies and to make the IR35 legislation easier to understand for those who are genuinely in business."
As the law stands at the moment, contracting with intermediary personal service companies is often the preferred way of engaging self employed contractors because of the protection the IR35 regime offers the client company (i.e. the company to which the services are provided) in relation to tax liabilities. Payment for the services is made by the client company to the personal service company. Broadly, if HMRC determine that the working relationship between the client company and the individual contractor is in fact one of employment, under the current IR35 regime, HMRC will look to the personal service company (rather than the client company) for recovery of income tax, NICs and any interest and penalties. In effect, the personal service company takes the main tax risk.
In the proposed measures announced in the budget, the Government said that it would consult on requiring office holders/controlling persons who are integral to the running of an organisation to have PAYE and NICs deducted at source "by the organisation by which they are engaged" even where they contract through a personal service company, effectively shifting the risk on tax from the personal service company to the client company. The Government is also intending to strengthen specialist compliance teams to tackle IR35 related tax avoidance and to simplify the IR35 rules themselves.
It is early days as far as this proposal is concerned and more will become clear when the consultation is launched. Nonetheless, whilst it appears that the proposals will only relate to very senior personnel, it could mean that client companies will need to consider more carefully taxation issues when engaging contractors through a personal service company.
- Personal service companies have been regarded as a good mechanism for client companies to manage the risks in relation to the engagement of independent contractors in terms of employment rights and tax. The Government's proposals to change this will mean that going forward a more cautious approach will need to be adopted.
- It will be even more important for client companies to include indemnities in contractual documentation in relation to tax and employment related liabilities, although they should be aware of the limitations of such provisions.
- We will keep you updated on relevant developments.