Tax Attack on Personal Service Companies
The latest victim of the Taxman's longstanding war against Personal Service Companies (a company through which individuals provide their services) is the unfortunate Mr Bessell and his company, Dragonfly Consultancy Ltd.
The history behind the use of personal service companies is that taxpayers have used them to reduce their tax burden in two ways. Firstly by paying themselves dividends to avoid National Insurance costs and, secondly, by sharing the income, usually with their spouse, in order to take advantage of the spouse's unused lower rate tax bands.
The attack on these companies became a serious issue in 2000 when the IR35 rules were implemented. Using these rules the government effectively sought to tax the individual on the income of the company on a PAYE basis if, without the protection of their company, they would be properly classed as employees. A very tax expensive result!
Taxpayers sought to avoid the application of IR35 by ensuring as far as possible that the contractual arrangements avoided the implication of employment status. Obviously, taxpayers ensured that their independence from the ultimate "employer" was emphasised and, in particular, the right to supply a substitute worker through the personal service company came to be seen as a silver bullet, destroying the Revenue's contention that employment status might apply.
The government intensified the war by trying to apply the "settlements legislation" to combat income splitting whereby the real earner shared the income with a partner whose input into the business was often minimal. This was an inappropriate use of the legislation and they eventually lost the case against their intended victims, Mr and Mrs Jones and their company, Arctic Systems. The Revenue retired to lick their wounds and formulate proper legislation to combat income splitting, which we have yet to see.
That's the potted history of events up to this year.
The latest event in the personal service company war is the Revenue's IR35 case against Mr Bessell and Dragonfly Consultancy Ltd. Mr Bessell worked as part of a team at the AA through his personal service company. Dragonfly's contract was actually with an agency and the terms did include the right to provide a substitute worker. However, this right was not reflected in the agency's contract with the AA and, to make matters worse, the AA's staff gave unhelpful evidence indicating they would not simply accept a substitute for Mr Bessell without question. The Revenue won the case on the question of control - Mr Bessell was under the AA's control and supervision effectively like an employee.
The point that has alarm bells ringing throughout the industry is the realisation that the flimsy substitution clause in the contract was not a get out of jail card for Mr Bessell. Now the government has announced that it will defer income splitting legislation and IR35 is clearly back to the fore in its armoury. Unfortunately, the unsatisfactory situation for taxpayers will persist: either they pay lots of tax by complying with IR35 or gamble with the dividend and income splitting games.
Those operating through personal service companies need to review their arrangements so that they can be kept as far from the Revenue's clutches as possible.
If you would like to discuss the potential implications for you, please contact Charles Green on 020 7022 0050.
If you would like to discuss the potential implications for you, please contact Charles Green on 020 7022 0050.
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