Personal Service Companies - Select Committee on Personal Service Companies Contents


Introduction and Background

65.  The primary focus of the Committee's investigation was on the use of personal service companies and the associated consequences for tax collection. The inquiry raised broad questions about the associated legislative framework. Within these broader issues, the core questions which we address stem from the IR35 legislation, its interpretation and HMRC's ability to administer and monitor it.

66.  The 1999 Budget Press notice 'IR35' which announced the introduction of the rules stated:

    "There has for some time been general concern about the hiring of individuals through their own service companies so that they can exploit the fiscal advantages offered by a corporate structure. It is possible for someone to leave work as an employee on a Friday, only to return the following Monday to do exactly the same job as an indirectly engaged 'consultant' paying substantially reduced tax and national insurance. The Government is going to bring forward legislation to tackle this sort of avoidance".[67]

67.  We were conscious that any consideration of the success or otherwise of the legislation should take account of these original aims and so we sought to investigate whether the practice outlined above was still commonplace. Whilst we heard very little evidence of individuals leaving employment only to return in a 'consultant' role, we did hear from some in the private sector about the commercial benefits of recruiting individuals through limited companies.[68]

68.  We were also interested in what drove people to incorporate more generally in the first place and the extent to which this was motivated by a potential tax advantage. HMRC explained to us that in their opinion, the growing phenomenon of personal service companies could be explained "primarily for commercial reasons but, it also has to be said, partly to avoid or mitigate tax".[69] In response to this, the IR35 legislation itself had been drafted to ensure that broadly the same tax is paid by applying a tax framework akin to that of a conventional employment relationship.

69.  There appear to be particular problems in having to apply the rules on a contract-by-contract basis, which can make them especially cumbersome. As mentioned in the previous Chapter,[70] the IR35 legislation applies to engagements which, but for the presence of an intermediary (such as the personal service company), would be regarded as conventional employment relationship. This has the aim of ensuring that broadly the same amount of tax and National Insurance is paid regardless of the use of an intermediary. This judgment is applied on a contract-by-contract basis, rather than by reference to the totality of the activity of the individual who works through a personal service company. Consequently, contractors find that they have to consider whether IR35 applies to each of the contracts under which they operate rather than establish the tax status of their personal service company.

70.  Our Call for Evidence[71] asked the following question: "To what extent does the current IR35 legislation impose additional compliance burdens and administrative costs?" This question sought to gather information on both the compliance and administrative costs to Government, in the form of HMRC, and to British business. The PCG told us of the expensive administrative and cost implications of contractors having to seek accountancy advice and private contract reviews.[72] We deal with HMRC's administration costs in Chapter 4.

71.  The IR35 legislation was initially justified on the basis of a significant risk to the Exchequer of the loss of tax and National Insurance revenue. HMRC initially told us that the Exchequer risk was £475m but when we asked them to provide further details we were told that the total estimated fiscal risk was now £550m. HMRC provided the Committee with a breakdown of this figure[73] which comprised an Exchequer yield of £30m and Exchequer protection of £520m, the latter figure having increased in recent years, partly because of a reduced estimated income threshold at which HMRC consider an individual may decide to establish and operate through a personal service company. We were told that the Exchequer protection figure was made up of:

(1)  £115m from people who currently provide their services through a personal service company and who would pay a greater proportion of their income through dividends in the absence of IR35. This is calculated as 220,000 directors estimated to be deterred from avoiding £500 per person on average; and

(2)  £405m which is made up of people who are currently directly employed who would incorporate and provide their employment services through a personal service company were it not for IR35. This is calculated as 55,000 employees who would incorporate and avoid tax and National Insurance of around £8,000 per person on average.[74]

72.  The reliability of these figures formed part of our questioning to HMRC when they appeared before us for the second time at the end of our inquiry. We were told that HMRC aimed to derive a reasonable central estimate of the costs of any measure in the Knowledge, Analysis and Intelligence Directorate and that this was subject to a quality assurance process before it was scrutinised further by the Office for Budget Responsibility.[75] It was not clear to us that these figures were reliable. The 220,000 directors cited in connection with Exchequer protection was a higher population than the figure of 200,000 which we were given for the number of operating personal service companies and it was not clear on what basis either this population or the figure of £500 per director had been calculated. In respect of the 55,000 employees who would move to incorporate in the absence of IR35, we were told that this represented 4% of employees who earn over £50,000. We were also told that the OTS had estimated that 1.8% of individuals with an employment income of between £50,000 and £150,000 might incorporate in the absence of IR35.[76] HMRC made it clear repeatedly that these overall figures were only estimates based on the available evidence. Given the critical importance of these calculations in justifying the existence of the IR35 legislation, we were of the opinion that more robust work was needed in this area.

73.  We recommend that Her Majesty's Revenue and Customs carry out and publish a detailed assessment of the current Exchequer protection figure and of the costs that taxpayers incur in dealing with IR35. This should enable a better assessment of whether the legislation is having the intended effect and is proportionate. (Recommendation 1)

The effectiveness of the legislation

74.  The Committee heard from a wide range of interested parties who consider that the current legislation is ineffective; a large number of the written submissions made this point forcefully. Contractor Calculator, an independent, online guide for contractors, stated that: "It does seem somewhat wasteful having industry experts and HMRC standing around a dead horse discussing how they can make it win the race. It's a non-runner, and has been since inception".[77] The broad sentiment expressed here was echoed by many. The Association of Accounting Technicians (AAT) and Chartered Institute of Payroll Professionals (CIPP) argued that the legislation was poorly thought through when drafted and remained unclear. Their argument seemed to be a qualitative one based on the ambiguity of the rules and uncertainty amongst taxpayers who were expected to abide by them. HMRC acknowledged that they were aware that many find the legislation difficult to understand but maintained that, on the whole, understanding had increased over the years.[78]

75.  A great deal of evidence was submitted which displayed a high degree of hostility to the legislation in its current form. Many viewed the legislation as outdated, attempting to address a situation and market which in reality no longer existed. We were told that HMRC were trying to apply an outdated method of taxation to a new, emerging way of working.[79] The IIM suggested that the 'rules' did not reflect the underlying reality of the way freelancers worked and the Interim Management Association (IMA) argued that the legislation needed updating to be more reflective of the maturing labour market. The reliance on case law as a method of assessment, and a preoccupation with defining the tax position on a contract-by-contract basis appeared to be the primary criticisms here and an alternative approach is discussed in the next Chapter.[80]

76.  Conversely, organisations such as G4S plc, Amey plc and Oil and Gas UK, all responding as clients of personal service companies, were more supportive. Amey plc suggested that the principles of IR35 were appropriate and pragmatic, whilst G4S plc suggested that, as a client, they felt that the legislation was effective and efficient in managing the tax risks of using intermediaries. We were told very clearly by various parties from the business sector that the status quo should be maintained, though it was less clear whether this was an objective assessment of the situation or simply an appraisal of how the current rules are beneficial for their current business models. We were also mindful that Government and the public sector are significant users of personal service companies, arrangements which can benefit all parties in a similar way to those in the private sector. The Confederation of British Industry (CBI) and the IoD echoed this sentiment of approval in their oral evidence to the Committee,[81] but again, their satisfaction was less rooted in the benefits for the Exchequer and more in the flexibility that current arrangements afforded to their members.

77.  It is clear that in certain situations, the use of personal service companies can be beneficial for business. The oral evidence given by Amey plc summarised the potential benefits well:

    "We need access to specialist skills, commonly at short notice, for a limited duration. To have that level of resource on the books permanently is expensive and inefficient if we have people sitting around waiting for a particular project to happen … if we need somebody for three months or six months and we give them an employment contract, that raises a whole host of issues that are disproportionate to the intended length of the relationship and can include equality of employee rights, auto­enrolment for pensions and involvement in our flexible benefits reward scheme. A lot of administrative structures are built around permanent employment that are simply not appropriate for somebody who is only going to be in the business for three or six months".[82]

78.  Serial contracting is a feature of the modern British workforce and is supported by both businesses and contractors. We heard that although IR35 is not a significant issue for businesses, it can arouse considerable hostility from contractors.

79.  Moreover, we note that compliance with the rules can demand a great deal of time and effort on the part of contractors. We acknowledge that it can be difficult for individuals contracting through personal service companies to define their tax and National Insurance position quickly and accurately because of the contract-by-contract nature of IR35 and the need for a sound understanding of case law.

The Call for Reform

80.  We were aware that there were strong opinions on the complexity and appropriateness of the IR35 legislation. As noted in Chapter 2, the Government asked the OTS to look at alternative approaches as part of its Review of Small Business Taxation which reported in 2011. Our Call for Evidence asked the following question: "Should the current intermediaries legislation be reformed and if so, what would be the alternatives?"

81.  The OTS's suggestion of an eventual merging of income tax and National Insurance[83] was supported in evidence to us by Professor Judith Freedman (Pinsent Masons Professor of Taxation Law at the University of Oxford), AAT, CIPP and Contractor Calculator.[84] Similar points were made by the ICAEW and Julius Hutson, a Chartered Accountant. This was rejected by the Government in their response to the OTS's report in 2011. [85]

82.  The OTS also presented some IR35 reform options in its 2011 report, the first of which was suspension of the legislation prior to permanent abolition. This was supported by the PCG[86] and others in evidence to us. On this point, Mr Whiting, Director of the OTS, stressed the deterrent effect of IR35 which would be difficult to quantify:

    "The risk would clearly be that if HMRC says that it is suspending IR35 and will not operate any investigations, people might say, 'Oh, it's open season, we can do what we like'. We recognised that, so we felt it would be possible to announce the suspension by saying, 'We are suspending it but not abolishing it, and if we see a marked move up in behaviour that would blatantly be caught by IR35, the suspension will be removed'. That is the risk that we had in mind".[87]

83.  As discussed above, a key question that emerged was whether HMRC's calculations of the deterrent effect of IR35 (Exchequer protection) are accurate and hence whether abolition would do more harm than good. This underpins Recommendation 1 which calls for a detailed assessment of the Exchequer protection estimates.

84.  The Government chose to pursue the OTS's option of improving the administration of the legislation[88] and we examine these changes later in this Chapter.

85.  We also heard other suggestions in evidence. The IIM suggested that IR35 should be replaced by a straightforward genuine self-employment certification process; a similar proposal was made by David Ramsden of the Federation of Small Businesses (FSB), although such a proposal was not common amongst the wider evidence. There would be clear benefits to such a system, but whether it would apply on a contract by contract basis and the administrative implications of this are unclear. There are clear arguments that people should be free to operate outside conventional employment structures if they wish to do so.[89] A more difficult question is whether that choice should be conclusive for tax purposes given the tax and National Insurance incentives that are on offer to those who operate through a corporate body.

86.  A number of suggestions for new 'rules', which may act to simplify the process were also made. Amey plc suggested that there might be a case for looking more closely at any engagement which lasted for more than a set period of time; other variants of this principle were also suggested detailing differing timescales. The Giant Group suggested that a minimum number of clients per year could be defined, or that a rule around any one client exceeding a certain percentage of personal service company turn-over could be developed. We were interested to hear from Professor Freedman that a percentage system is used in Australia, though the extent to which this is effective is unclear.[90]

87.  We believe that the abolition or suspension of the IR35 legislation as proposed by the Office of Tax Simplification, whilst attractive, would be unwise if the legislation has the Exchequer protection effect claimed for it by Her Majesty's Revenue and Customs.

88.  The current structure and rates of income tax and National Insurance provide an incentive for taxpayers to arrange their financial affairs in order to minimise the amount of tax and National Insurance paid. This has lead to complex legislation, such as IR35, to counter such arrangements.

89.  Whilst we recognise the complexities in merging income tax and National Insurance and the effect that this may have on the contributory principle, we recommend that the Government re-examine the longer term case for combining taxes on income and National Insurance. (Recommendation 2)


90.  In the first draft of the IR35 legislation the onus was intended to rest with the end-user rather than the individual in determining whether IR35 should apply to a contract. The Committee's Call for Evidence therefore asked: "Do businesses insist on the use of personal service companies? If so, should responsibility be placed on them rather than the worker to decide whether a business transaction falls within IR35?"

91.  Currently, the responsibility to take due account of IR35 and associated personal service company legislation rests with the individual who is operating through the personal service company. Efficient and effective tax-collection appears to occur only when the individuals concerned are soundly advised and aware of the complexities involved. For those who do not fall into this category, the expectation that they will declare their status as falling within the intermediaries legislation seems to be rather optimistic as detailed in Chapter five. It has been suggested that the responsibility for assessing IR35 compliance should move from the individual operating through the personal service company to the end-user. The Committee heard that a greater level of responsibility could fall on the engager as was first proposed in the Government's consultation prior to the introduction of the IR35 legislation. The ICAEW suggested that engagers should bear the responsibility if they insist in engaging an individual through a personal service company;[91] others argued that they should be held responsible for any unpaid tax resulting from disguised employment.

92.  Although taking this step would remove the responsibility from the individual operating through a personal service company, it would place significant administrative pressure on engaging businesses. The CBI argued that the legal responsibility for determining IR35 status should remain with the personal service company; this view seemed to be shared by most of those from the world of business and was convincingly put to the Committee by GlaxoSmithKline plc (GSK):

    "I do not think it would be appropriate for, say, GSK to be accountable for the personal service company paying the appropriate amount of tax. It is a decision made by the worker … they clearly are aware of what it means to set up a personal service company and so on, so the accountability needs to be with the personal service company. We have no thoughts on how to modify the rules that would change that".[92]

Although there are many instances in which businesses undertake elements of the administrative work of collecting taxes such as PAYE and the Construction Industry Scheme (CIS), the majority of the evidence we received did not support placing the onus on businesses to make judgements about whether contracts fall within the IR35 rules.

93.  We received much evidence on the questions posed on the various tax return documents, specifically the personal tax return SA100 and the employer tax return P35, which was used before the introduction of Real Time Information (RTI). In the case of the latter, we noted that similar questions must still be answered in the year end declarations made by employers online. In each case, HMRC references 'service companies' with questions aimed at detecting activity from both sides of contracting activity, but without a detailed articulation of what 'service company' means. The SA100 form defines the term as "a company which provides your personal services to third parties", but gives no indication that IR35 may need to be considered. Indeed, the guidance note SA150 limits the explanation of what constitutes a 'service company' to the following paragraph, again without referencing IR35:

    "You provided your services through a service company if:

·  you performed services (intellectual, manual or a mixture of both) for a client (or clients); and

·  the services were provided under a contract between the client(s) and a company of which you were, at any time during the tax year, a shareholder; and

·  the company's income was, at any time during the tax year, derived wholly or mainly (that is, more than half of it) from services performed by the shareholders personally.

    Do not complete this box if all the income you derived from the company was employment income".[93]

We were of the firm opinion that this was a missed opportunity to raise awareness of the potential tax consequences of operating through a personal service company.

94.  We also heard that in many cases the questions were left unanswered. HMRC told us the following:

    "For 2011-12, which is the last year for which we have the data, 1,000 individuals completed the question on the income tax self-assessment return and 120,000 employers answered "yes" to the question on the P35 that they were a service company. Demonstrably, the difference between the two figures and the difference between the 1,000 and the 200,000 figure, which we estimate as the number of personal service companies, demonstrates that the number of people completing the question on the income tax self-assessment return is extremely low. We believe that is for a number of factors: in some cases ignorance, in some cases a conscious decision not to complete".[94]

95.  When asked about the purpose of the question, HMRC told us that although they may consider any lack of completion as a risk indicator, they do not see it as a "key question"[95] that would render the individual liable to penalties for an incorrect completion. We did not understand HMRC's rationale for asking questions on the tax returns but not considering their completion as important or insisting that taxpayers complete them.

96.  HMRC's role in advising the tax-payer of the risk of a particular engagement falling within IR35 through their Contract Review Service and in delivering a judgment after an investigation was a constant feature of the evidence given to the inquiry and is discussed in more detail in the following Chapter. Professional Passport, a membership body operating across the flexible workforce sector, stated that the majority of individuals now operating through personal service companies were more aware of their responsibilities than before. It is clear that whoever bears the responsibility for judging whether IR35 applies needs to be soundly advised and well informed.

97.  We acknowledge that businesses would generally resist being made responsible for IR35 assessment, finding the additional administrative pressure and liability as overly burdensome.

98.  We recommend that Her Majesty's Revenue and Customs look again at whether they require complete and accurate responses to the "service company" questions on the personal tax return SA100 and the RTI employer year end declaration (formerly P35). (Recommendation 3)

99.  If Her Majesty's Revenue and Customs decide that they need the information from those questions, we recommend that their completion should be made compulsory, backed up by the potential for penalties to be charged for incorrect answers or non-completion. (Recommendation 4)

100.  If Her Majesty's Revenue and Customs retain the questions, we recommend that they revise the guidance notes accompanying the personal tax return SA100 and the RTI year end declaration by employers to make the relationship to IR35 clearer. (Recommendation 5)

101.  If Her Majesty's Revenue and Customs decide that they do not need the information gained from the questions, we recommend that the questions be removed from the tax returns and declarations. (Recommendation 6)

67   Appendix 5 Back

68   Oil and Gas UK and Amey plc Back

69   Q 5 Back

70   Paragraphs 44 and 45 Back

71   Appendix 3. Back

72   PCG. Back

73   HMRC, Q2 and Q116 Back

74   HMRC and Q116 Back

75   Q 116 Back

76   Q 116 Back

77   ContractorCalculator Back

78   Q 8 Back

79   Peter Disney Back

80   Paragraph 131. Back

81   QQ 93-104 Back

82   Q 76 Back

83   The issue has been a continuous thread in the discussion of tax reform in the United Kingdom and has recently been discussed in a Ten Minute Rule Bill in the House of Commons which had the primary aim of changing the name of National Insurance to Earnings Tax. See HC Deb, 25 February 2014, cols 164-166. Back

84   AAT, CIPP and ContractorCalculator  Back

85   Government Response to the recommendations of the Office of Tax Simplification's Small Business Tax Review, 2011. Back

86   PCG Back

87   Q 14 Back

88   Government Response to the recommendations of the Office of Tax Simplification's Small Business Tax Review, 2011. Back

89   PCG Back

90   Paragraph 131. Back

91   ICAEW Back

92   Q 110 Back

93   HMRC Document, SA150. Back

94   Q 118 Back

95   Q 118 Back

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