April 7 2014.

Her Majesty's Revenue and Customs need to do more to demonstrate that the revenue protection they claim for the IR35 legislation outweighs the costs it imposes says the House of Lords Select Committee on Personal Service Companies in its report, published today.

The Chairman of the Committee, Baroness Noakes, said: "During the inquiry, it became clear to us that there is an increasing use of personal service companies by freelancers and contractors, who are part of the UK's flexible workforce. There are many reasons for the use of personal service companies, including the possibility of reducing tax and national insurance bills. The Government’s anti-avoidance legislation, often referred to as IR35, is complex and raises its own problems.

"We found that there is a general lack of information of how widespread the use of personal service companies is in the UK economy and that this is due, in no small part, to the absence of reliable information collected by HMRC. This could be rectified by amending the personal tax return and employer year end declaration and making the questions on service companies compulsory, rather than optional.

"HMRC failed to demonstrate that they had a sound basis for the £550m of tax and national insurance that they cited as being at risk if IR35 were to be abolished or suspended. The deterrent nature of the IR35 legislation is its main rationale. We recommend that HMRC publish a detailed assessment of this figure and we also call for an assessment to be made of the cost to the taxpayers affected by the rules.

"Whilst we commend HMRC on the establishment of the IR35 forum as a means of greater stakeholder engagement, we believe that HMRC should consult on revising the 'Business Entity Tests' and should make the Contract Review Service more effective."

Other findings
Baroness Noakes continued: "We also received evidence that low-paid workers may also be employed via personal service companies and that they may not be aware that this means they have fewer employment rights. We believe that this is something which needs to be thoroughly assessed by the Low Pay Commission. We also recommend that the Government produce a short guide setting out the basic differences between employment and self-employment; this would help to reduce some of the confusion experienced by those who are not in conventional employment situations.

"We also recommend that further measures are taken to build confidence in the public sector's management of off-payroll engagements and that the Treasury take a leading role in this."

Intermediaries Legislation (IR35) - Working through an intermediary, such as a Personal Service Company

The Intermediaries legislation was introduced on 6th April 2000. It was first proposed by the Chancellor in the 1999 Budget and details were given in the Budget press release numbered IR35. Following extensive consultation, revised proposals were announced in a new press release dated 23 September 1999. However, the legislation is now commonly referred to as ‘IR35’.

The aim of the legislation is to eliminate the avoidance of tax and National Insurance Contributions (NICs) through the use of intermediaries, such as Personal Service Companies or partnerships, in circumstances where an individual worker would otherwise -

For tax purposes, be regarded as an employee of the client; and
For NICs purposes, be regarded as employed in employed earner’s employment by the client.
Prior to the introduction of the legislation, an individual could avoid being taxed as an employee on payments for services and paying Class 1 NIC by providing those services through an intermediary. The worker could take the money out of the intermediary, normally a Personal Service Company, in the form of dividends instead of salary. As dividends are not liable to NICs, the use of a dividend remuneration strategy results in the worker paying less in NICs than either a conventional employee or a self-employed person. And PAYE would not apply to the dividends.

The legislation ensures that, if the relationship between the worker and the client would have been one of employment had it not been for an intermediary the worker pays broadly tax and NICs on a basis which is fair in relation to what an employee of the client would pay.

On 6 April 2007 Chapter 9 ITEPA 2003, more commonly known as the Managed Service Company (“MSC”) Legislation, was introduced. The MSC Legislation applies to individuals providing their services through intermediaries which meet the definition of a Managed Service Company.

An intermediary must consider whether the MSC Legislation applies before considering IR35. Intermediaries that do not meet the definition of an MSC must continue to consider IR35.

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