Tax returns controversy for service companies
A new question on the 2007/08 tax returns has caused controversy because of the ambiguous wording of HM Revenue & Customs’ (HMRC) explanatory notes and because it appears designed to highlight taxpayers for enquiry.
People who provide services ‘through a service company’ are asked to state the total amount of income derived from doing so, even though this income – generally employment remuneration and dividends – is reported elsewhere in the tax return.
The term ‘service company’ is much wider than companies caught by the IR35 rules. For the tax return question, services are provided through a service company where the shareholders provide intellectual or manual services to the company’s clients and more than half the company’s income (before deducting expenses) is derived from their work. If more than half the company’s income consists of charges to cover materials or work done by employees, you need not answer the question.
The ambiguity in HMRC’s explanatory notes resulted in HMRC issuing a revised explanation in September and a statement that there would be no adverse consequences for taxpayers who completed the question or left it blank in a tax return filed before then. The new explanation adds that you need not keep any additional records to determine whether more than half the company’s income is derived from services performed by the shareholders, but that ‘best judgement’ may be used.
It is hard to escape the fact that answering the question might result in HMRC opening an enquiry to determine whether the company falls within the IR35 rules, although HMRC’s limited resources will mean that only a small percentage of tax returns will be questioned. If it is clear that the company’s engagements are outside IR35, such an enquiry would have no consequences apart from being a nuisance.
Not answering the question may also result in an enquiry if HMRC thinks you should have done so. You may also leave yourself open to an enquiry after the normal time limit of one year after HMRC receives your tax return, because HMRC may argue that you have not provided enough information for it to be sure that your tax return is correct.
If you are concerned that you may fall within IR35, you should get in touch with us now.