Back in the 1970's, HMRC advised businesses who were worried about employment status that if the person worked through them as a limited company, there was no employment issue.
The law has not really changed, but the implications have and this has come from two directions.
We have seen successful tribunal cases brought by individuals who worked through a personal service company (PSC), which were essentially looking to secure employment rights.
These cases were relatively rare, but HMRC is now increasingly concerned not over employment rights, but income. The income they are worried about is National Insurance (NI) both from the employee and the employer.
It is nothing new that HMRC are trying to take steps to create a reason to charge a PSC with an NI cost.
IR35 was the original foray and that initially was pretty ineffective. Now, we are almost taking a view more akin to the old Ramsay one; if the purpose of the arrangement is purely with a view of reducing taxes, then the arrangement can be ignored.
In the last Budget it was made even clearer that PSCs are now seen purely as a mechanism for avoiding tax and the noose is going to be increasingly tightened.
So, here's a quick view of what might be at stake and to what extent people might create a story that would make sense.
The monies come into the PSC, which can then be paid out in a variety of ways. Salaries we might restrict to pay no NI and maybe have a spouse/partner as a director taking a similar salary. We might also have some travelling expenses that if we were an employee might not be claimable because we argue the main place of work is at home.
There might be other expenses which can be put through the company as legitimate tax deductible business expenses which if were incurred as an employee might not, under the stricter deductibility rules be claimable.
Whilst many might be using PSCs for all the correct and valid commercial reasons, which is why many IR35 claims have failed, they are now being seen by the government as a tax avoidance vehicle because of the frequent use of the system by high paid 'employees'.
These are often previous employees who have had severance packages and immediately come back as consultants through their PSC.
Here is a quick example as to how the system might be used:
Mr Smith is married working for a large corporate business on a salary of £150,000. His wife does not work and has no income. He has always worked partly from home and partly at an office based the company's premises and spends £3,000 per year on travelling to and from the company office.
Below is a simple example of how the use of a PSC might work if salaries are pitched at such a level as to just use personal allowances and all the post-tax PSC income is distributed as dividends assuming shares are split 70% to Mr Smith and 30% to Mrs Smith.
Because the employing company is now going to save on employer's NI and other employment risks they have decided as part of the deal to increase the annual payment for Mr Smith's services from the £150,000 salary to £165,000. In the example, it is assumed there are no other employment benefits and Mr Smith has opted out of all pension arrangements.
As you can see the savings, at the cost of HMRC are fairly dramatic - the employing company in cash terms alone has saved nearly £5,000 and the Smith family is now £26,498 or 30.43% better off and HMRC has 'lost' over £31,000 or over 39% of the previous take!
This explains why the government are taking such a keen interest in PSCs, but it does mean that many quite sensible and commercially structured, independent businesses may now be caught in the crossfire.
The example above would probably find it hard to pass even the tests of IR35 and would be able to be challenged under the income splitting rules and potentially fall foul of the disguised remuneration rules.
When it comes to expenses there are two key common sense tests:
Assuming you are not in an IR35 situation and you look at the disguised remuneration rules, the question is going to be: are monthly dividends the norm in business? The answer is no.
In a company situation, workers are paid a salary for doing the job they do and the owners get dividends.
So what would be the minimum salary that you might expect to pay someone to do the job you are doing? In reality, you have a difficult argument if you are paying yourself less than that to say that some of the dividends are not remuneration!
But equally, if you are paying yourself what someone might earn and only paying profits over and above that out in dividends HMRC have the difficult case to argue.
When it comes to income splitting and providing a spousal salary the same process holds true -is the wage fair for the job? Shared ownership for dividends, does that represent a true share of ownership/risk?
The laws to a large degree have not changed although there are a few additional regulations, but the application and interpretation is being tightened in HMRC's favour so make sure your reasoning is sensible and defendable just in case the engagement and methods of payment are challenged, as you may have to defend your actions in future.
What do you think of the changes? Log in or sign up to UKBF to comment below.
The law has not really changed, but the implications have and this has come from two directions.
We have seen successful tribunal cases brought by individuals who worked through a personal service company (PSC), which were essentially looking to secure employment rights.
These cases were relatively rare, but HMRC is now increasingly concerned not over employment rights, but income. The income they are worried about is National Insurance (NI) both from the employee and the employer.
It is nothing new that HMRC are trying to take steps to create a reason to charge a PSC with an NI cost.
IR35 was the original foray and that initially was pretty ineffective. Now, we are almost taking a view more akin to the old Ramsay one; if the purpose of the arrangement is purely with a view of reducing taxes, then the arrangement can be ignored.
In the last Budget it was made even clearer that PSCs are now seen purely as a mechanism for avoiding tax and the noose is going to be increasingly tightened.
So, here's a quick view of what might be at stake and to what extent people might create a story that would make sense.
Basic concept of a PSC
The basic concept of the simple PSC is that an individual secures a contract (which might otherwise have been employment) and has it made out in the name of the PSC.The monies come into the PSC, which can then be paid out in a variety of ways. Salaries we might restrict to pay no NI and maybe have a spouse/partner as a director taking a similar salary. We might also have some travelling expenses that if we were an employee might not be claimable because we argue the main place of work is at home.
There might be other expenses which can be put through the company as legitimate tax deductible business expenses which if were incurred as an employee might not, under the stricter deductibility rules be claimable.
Whilst many might be using PSCs for all the correct and valid commercial reasons, which is why many IR35 claims have failed, they are now being seen by the government as a tax avoidance vehicle because of the frequent use of the system by high paid 'employees'.
These are often previous employees who have had severance packages and immediately come back as consultants through their PSC.
Here is a quick example as to how the system might be used:
Mr Smith is married working for a large corporate business on a salary of £150,000. His wife does not work and has no income. He has always worked partly from home and partly at an office based the company's premises and spends £3,000 per year on travelling to and from the company office.
Below is a simple example of how the use of a PSC might work if salaries are pitched at such a level as to just use personal allowances and all the post-tax PSC income is distributed as dividends assuming shares are split 70% to Mr Smith and 30% to Mrs Smith.
Because the employing company is now going to save on employer's NI and other employment risks they have decided as part of the deal to increase the annual payment for Mr Smith's services from the £150,000 salary to £165,000. In the example, it is assumed there are no other employment benefits and Mr Smith has opted out of all pension arrangements.
As you can see the savings, at the cost of HMRC are fairly dramatic - the employing company in cash terms alone has saved nearly £5,000 and the Smith family is now £26,498 or 30.43% better off and HMRC has 'lost' over £31,000 or over 39% of the previous take!
This explains why the government are taking such a keen interest in PSCs, but it does mean that many quite sensible and commercially structured, independent businesses may now be caught in the crossfire.
The example above would probably find it hard to pass even the tests of IR35 and would be able to be challenged under the income splitting rules and potentially fall foul of the disguised remuneration rules.
But what can genuine businesses do about it?
Firstly, they need to appreciate that their businesses are going to be coming under ever more scrutiny and questions may well be asked, so the important thing is to have your story and justification - backed up by conduct - ready.When it comes to expenses there are two key common sense tests:
- If you have only incurred the expense because you are in business then it is probably a business expense, but more importantly the other way round
- If you had not been in business would you still have had the expense - if the answer is yes then it is probably not a business expense
- If you have incurred an expense you would, if you had been an employee, reasonably have expected your employer to reimburse you - that is probably a genuine business expense
Assuming you are not in an IR35 situation and you look at the disguised remuneration rules, the question is going to be: are monthly dividends the norm in business? The answer is no.
In a company situation, workers are paid a salary for doing the job they do and the owners get dividends.
So what would be the minimum salary that you might expect to pay someone to do the job you are doing? In reality, you have a difficult argument if you are paying yourself less than that to say that some of the dividends are not remuneration!
But equally, if you are paying yourself what someone might earn and only paying profits over and above that out in dividends HMRC have the difficult case to argue.
When it comes to income splitting and providing a spousal salary the same process holds true -is the wage fair for the job? Shared ownership for dividends, does that represent a true share of ownership/risk?
The laws to a large degree have not changed although there are a few additional regulations, but the application and interpretation is being tightened in HMRC's favour so make sure your reasoning is sensible and defendable just in case the engagement and methods of payment are challenged, as you may have to defend your actions in future.
What do you think of the changes? Log in or sign up to UKBF to comment below.
