Can an employee – normally a company director – be liable personally for IR35?
Possibly, but in many cases no. As is often the way, the devil is in the detail.
UNDERSTANDING THE SETTING
First, IR35 – ignoring the rare occurrences of it applying in a partnership – is an
employment tax –that’s to say it operates as part of the PAYE system, and
responsibility sits with the employer, i.e. the PSC.
Bear in mind here the PSC is a Limited Liability Company distinct in law from its
shareholders (aka members) and directors, and only in certain tightly defined
circumstances are they liable for company debts.
So, in the first instance, if an adverse IR35 finding is made by HMRC and either (i)
unchallenged or (ii) lost on appeal, then the liability sits with the company.
But what if the company doesn’t have the funds?
Well, here Regulation 72 comes in – Regulation 72 PAYE Regulations 2003, which
deals with personal liability for tax not paid by a employer.
THE PAYE REGULATIONS
Regulation 72 refers to the 2003 PAYE regulations, and here we hit the first problem
– although published on the www.legislation.gov.uk website, and cross referenced
there from HMRC, the published version is as originally written and does not reflect
amendments made by later legislation – it’s quite common for a later correction to
amend the original regulations, and it would be helpful if HMRC or HM Government
draughtsmen published a definitive corrected version. Alas they don’t seem to, so the
first thing to do is piece the rules together from later amendments. See the appendix
to this briefing for that.
Then it’s a case of interpreting Regulation 72.
The key parts in Regulation 72 are Conditions A and B in sections (3) and (4), as
originally written – in certain circumstances these transfer an employer’s liability to
an employee, including a company director.
Later additions to Regulation 72 cover:
~ appeal rights – sections 72 A, B, C and D, included in 2004
~ sections 72 E to G added in 2008 which deal with matters to do with notional
payments. Although it’s not clear from the regulations, Regulations E to G and
notional payments have no impact on IR35 deemed payments – Section 710 ITEPA
2003 defines notional payments by reference to s 687, 689 and 693 to 700 ITEPA
2003 – the IR35 legislation nestles separately in 48 to 61 ITEPA. Although the IR35
legislation makes the IR35 deemed payment a form of deemed remuneration, that
only works to join IR35 deemed payments to remuneration in general, and not to
make it a notional payment for these purposes.
So, A and B in sections (3) and (4) Regulation 72 are the points in contemplation.
Before examining these – lets quickly check elsewhere in the PAYE regulations, eg
regulations 80/81 and their cross sections regulations 68, 76, 77, 78 and 79 – and in
turn a reference to Regulation 62(5) and notional payments again – well, there is
nothing here that specifically addresses either IR35 or transfers of liability, other than
Regulation 81 and that refers to Regulation 62(5) notional payments, which takes us
back to regulation 72 E to G and – Section 710 ITEPA.
The reader will realise this is a veritable wild goose chase of interpretation, and not
always clear!
A final complication is that slightly different rules apply for National Insurance versus
Income Tax/PAYE – which Regulation 72 addresses – although for all practical
purposes the result will be the same.
CONDITIONS A AND B
So, what do they say?
Condition A is that the employer satisfies HMRC —
(a)that the employer took reasonable care to comply with these Regulations, and
(b)that the failure to deduct the excess was due to an error made in good faith.
Condition B is that HMRC are of the opinion that the employee has
received relevant payments knowing that the employer wilfully failed to deduct the
amount of tax which should have been deducted from those payments.
These are standalone provisions; either A or B applying by itself is enough to trigger a
transfer of liability.
The key to a rebuttal of a transfer of liability under these conditions will be that the
company, and its directors, acted reasonably and diligently. This is best illustrated by
two contrasting examples, Fred and Freda, both contractors, and both operating
PSCs. Let’s suppose both suffered IR35 investigations and HMRC concluded they
were caught by IR35. Let’s also assume all appeals have been exhausted and their
companies have no funds to meet the liability:
Fred – realised that he may have a risk under IR35, and therefore took steps to
protect himself and his company, eg:
~ advice on the content of his contracts
~ formal contract reviews
~ retained a portfolio of evidence showing outside IR35 status
~ endeavoured to work in an IR35 friendly way
It was close, but HMRC found against him.
Freda – she had heard of IR35 but didn’t really worry about assuming it was
something she could bluff her way around if there was ever a problem. In the
event of HMRCs investigation, she couldn’t.
Immediately its obvious Fred has been diligent, Freda hasn’t.
In this example Fred will be in a strong position to resist an assessment personally
under Regulation 72, Freda much less so.
From Fred’s perspective, Condition A can be defended in two ways.
First, by simply not making any claim under Condition A which is constructed to be
employer driven – basically don’t dig a hole for yourself! Regulation 72A(1) added
in 2004 makes it clear that a director for Condition A to apply is to be made by the
employer.
Secondly, for condition A, by challenging its second limb, i.e.(b)that the failure to
deduct the excess was due to an error made in good faith. Instead they would assert
that there was no error, merely a differing interpretation of views with HMRC. That
may sound like a slim distinction, but it needs to be recalled that IR35 is both
complex and imprecise, and works on a “hypothetical contract” which doesn’t exist
and is merely that, hypothetical. The key here is not to disprove good faith, but to
disprove error – but this is semantics, and whilst it’s a defence of last resort, its better
to simply take the first line of defence – that condition A is driven by employer
request – and not make a request.
Its not clear whether HMRC could apply Condition A without the employers request?
The bare reading of 72(3) is open on this point, but clearly 72A(1) would be brought
into play to show its intended to be a direction made at the employers request. We
are not aware of any litigation on this point, but clearly HMRC would be facing an
uphill battle to argue the other way.
Condition B is much easier for Fred to defend. The central premise of Condition B is
knowing that the employer wilfully failed to deduct the amount of tax and in Fred’s
case the employer didn’t wilfully do that – they made every effort to consider the
IR35 rules and comply; that in the event, HMRC found the other way, is a difference
of opinion and not a wilful failure.
Bringing this together, Fred would be in a strong place to defend any attempt by
HMRC to transfer liability.
In fact a few years ago one of our clients was in this very situation – an IR35
assessment by HMRC after a long IR35 investigation, which concluded after the
individual had returned to permanent employment and closed his company down.
HMRC initially sought to apply Regulation 72, but it was, after some exchanges,
agreed that Regulation 72 didn’t apply – HMRCs IR35 assessment was thus a hollow
victory for them, other than the immense stress caused to the client.
But what about Freda – the fact that she – both individually and as director of her
company – simply ignored IR35 puts her in a much weaker position. She can
probably get around condition A, but she has little defence open to her under
condition B and would be unlikely to be able to defend HMRC’s transfer of liability.
CONCLUSIONS
This is a less than clear area of tax practice, and one which hasn’t been litigated to
give any certainty.
However an individual who both personally, and as a company director, has been
diligent and careful is likely to be able to protect their personal position. Someone
who has not been so diligent would probably be less successful.
APPENDIX – REGULATION 72
http://www.legislation.gov.uk/uksi/2003/2682/regulation/72/made
Recovery from employee of tax not deducted by employer
72.—(1) This regulation applies if—
(a)it appears to the Inland Revenue that the deductible amount exceeds the amount
actually deducted, and
(b)condition A or B is met.
(2) In this regulation—
“the deductible amount” is the amount which an employer was liable to deduct from
relevant payments made to an employee in a tax period;
“the amount actually deducted” is the amount actually deducted by the employer from
relevant payments made to that employee during that tax period;
“the excess” means the amount by which the deductible amount exceeds the amount
actually deducted.
(3) Condition A is that the employer satisfies the Inland Revenue—
(a)that the employer took reasonable care to comply with these Regulations, and
(b)that the failure to deduct the excess was due to an error made in good faith.
(4) Condition B is that the Inland Revenue are of the opinion that the employee has
received relevant payments knowing that the employer wilfully failed to deduct the
amount of tax which should have been deducted from those payments.
(5) The Inland Revenue may direct that the employer is not liable to pay the excess to
the Inland Revenue.
(6) If a direction is made, the excess must not be added under regulation 185(5) or
188(3)(a) (adjustments to total net tax deducted for self-assessments and other
assessments) in relation to the employee.
(7) If condition B is met, tax payable by an employee as a result of a direction carries
interest, as if it were unpaid tax due from an employer, in accordance with regulation
82 (interest on tax overdue).
(8) The tax payable carries interest from the reckonable date until whichever is the
earlier of—
(a)the date on which payment is made, or
(b)the date (if any) immediately before the date on which it begins to carry interest
under section 86 of TMA(1).
—
http://www.legislation.gov.uk/uksi/2004/851/regulation/4/made
“Employer’s request for a direction and appeal against refusal
72A.—(1) In relation to condition A in regulation 72(3), the employer may by notice
to the Inland Revenue (“the notice of request”) request that the Inland Revenue make
a direction under regulation 72(5).
(2) The notice of request must—
(a)state—
(i)how the employer took reasonable care to comply with these Regulations; and
(ii)how the error resulting in the failure to deduct the excess occurred;
(b)specify the relevant payments to which the request relates;
(c)specify the employee or employees to whom those relevant payments were made;
and
(d)state the excess in relation to each employee.
(3) The Inland Revenue may refuse the employer’s request under paragraph (1) by
notice to the employer (“the refusal notice”) stating—
(a)the grounds for the refusal, and
(b)the date on which the refusal notice was issued.
(4) The employer may appeal against the refusal notice—
(a)by notice to the Inland Revenue,
(b)within 30 days of the issue of the refusal notice,
(c)specifying the grounds of the appeal.
(5) For the purpose of paragraph (4) the grounds of appeal are that—
(a)the employer did take reasonable care to comply with these Regulations, and
(b)the failure to deduct the excess was due to an error made in good faith.
(6) If on appeal under paragraph (4) it appears to the Commissioners that the refusal
notice should not have been issued they may direct that the Inland Revenue make a
direction under regulation 72(5) in an amount the Commissioners determine is the
excess for one or more tax periods falling within the relevant tax year.
Employee’s appeal against a direction notice where condition A is met
72B.—(1) An employee may appeal against a direction notice under regulation
72(5A)(a)—
(a)by notice to the Inland Revenue,
(b)within 30 days of the issue of the direction notice,
(c)specifying the grounds of the appeal
(2) For the purpose of paragraph (1) the grounds of appeal are that—
(a)the employer did not act in good faith,
(b)the employer did not take reasonable care, or
(c)the excess is incorrect.
(3) On an appeal under paragraph (1) the Commissioners may—
(a)if it appears to them that the direction notice should not have been made, set aside
the direction notice; or
(b)if it appears to them that the excess specified in the direction notice is incorrect,
increase or reduce the excess specified in the notice accordingly.
Employee’s appeal against a direction notice where condition B is met
72C.—(1) An employee may appeal against a direction notice under regulation
72(5A)(b)—
(a)by notice to the Inland Revenue,
(b)within 30 days of the issue of the direction notice,
(c)specifying the grounds of the appeal.
(2) For the purpose of paragraph (1) the grounds of appeal are that—
(a)the employee did not receive the payments knowing that the employer wilfully
failed to deduct the amount of tax which should have been deducted from those
payments, or
(b)the excess is incorrect.
(3) On an appeal under paragraph (1) the Commissioners may—
(a)if it appears to them that the direction notice should not have been made, set aside
the direction notice; or
(b)if it appears to them that the excess specified in the direction notice is incorrect,
increase or reduce the excess specified in the notice accordingly.
Appeals: supplementary provisions
72D.—(1) This regulation applies to appeals under regulations 72A(4), 72B, 72C and
81A.
(2) Subject to paragraph (4), an appeal is to the General Commissioners but the
employer or employee as appropriate may elect (in accordance with section 46(1) of
TMA(1)) to bring the appeal before the Special Commissioners instead.
(3) Section 31D(2) to (7) of TMA(2) (election to bring appeal before Special
Commissioners) has effect in relation to an election under paragraph (2) (as in relation
to an election under subsection (1) of that section).
(4) If in respect of the same error by an employer in relation to condition A in
regulation 72(3)—
(a)more than one employee is appealing under regulation 72B; or
(b)there is an appeal by an employer under regulation 72A(4) and by an employee
under regulation 72B
the Commissioners who are to determine the appeals are given in paragraphs (5) to
(7).
(5) If—
(a)the same body of General Commissioners has jurisdiction with respect to all the
persons concerned, and
(b)none of those persons has elected in accordance with section 46(1) of TMA to
bring the appeal before the Special Commissioners
the appeals are to be determined by that body of General Commissioners.
(6) If—
(a)different bodies of General Commissioners have jurisdiction with respect to the
persons concerned, and
(b)none of those persons has elected in accordance with section 46(1) of TMA to
bring the appeal before the Special Commissioners
the appeals are to be determined by such of those bodies as the Board of Inland
Revenue determine.
(7) In any other case, the appeals are to be determined by the Special Commissioners.
(8) Where paragraph (4) applies or the appeal is material to the liability to tax of the
employer and the employee, all the persons concerned are entitled—
(a)to appear before and be heard by the Commissioners, or
(b)to make representations in writing
(9) On hearing an appeal the General Commissioners or the Special Commissioners
may allow the employer or employee as appropriate to put forward grounds not
specified in the notice, and take them into consideration, if satisfied that the omission
was not wilful or unreasonable.”.
—
http://www.legislation.gov.uk/uksi/2008/782/regulation/7/made
“Conditions where regulation 72F applies
72E.—(1) Regulation 72F applies where—
(a)an employee has received a relevant payment;
(b)it appears to HMRC that an amount intended to represent tax on the payment—
(i)has been self-assessed, or
(ii)has not been self-assessed, but has been paid under section 59A TMA(1)
(payments on account of income tax), section 559A of ICTA(2) (treatment of sums
deducted under s.559 (sub-contractors)) or section 62 of the Finance Act 2004(3)
(treatment of sums deducted (sub-contractors));
(c)any of conditions A, B and C is met;
(d)a trigger event has occurred; and
(e)a trigger event did not occur before 6th April 2008.
(2) Condition A is that it appears to HMRC that the amount which the employer was
liable to deduct—
(a)from the relevant payment; or
(b)in the case of a notional payment, from other relevant payments,
exceeds the amount actually deducted.
(3) Condition B is that it appears to HMRC that the amount for which the employer
was required to account under regulation 62(5) (notional payments) in respect of the
relevant payment exceeds the amount actually accounted for.
(4) Condition C is that—
(a)tax on the relevant payment was included in a determination under regulation 80
(determination of unpaid tax and appeal against determination); and
(b)the full amount of the determination is not paid within 30 days from the date on
which the determination became final and conclusive.
(5) The following are trigger events—
(a)HMRC serve notice of a determination under regulation 80 that includes tax on the
relevant payment;
(b)HMRC receive a return under section 8 of TMA(4) (personal return) which
includes a self-assessment which includes tax on the relevant payment as tax treated
as deducted;
(c)HMRC receive—
(i)an amended return under section 9ZA of TMA(5) (amendment of personal or
trustee return by taxpayer), or
(ii)a claim under section 33 of TMA(6) (error or mistake),which includes tax on the
relevant payment as tax treated as deducted;
(d)HMRC receive a letter of offer.
(6) In paragraph (5)—
“letter of offer” means an offer in writing by the employer to agree an amount in
settlement of the employer’s liability to pay an amount that includes tax on the
relevant payment;
“tax treated as deducted” has the meaning given by regulation 185(6).
(7) For the purposes of this regulation tax is self-assessed if—
(a)it is included in a return under section 8 of TMA which includes a self-assessment;
and
(b)ignoring any relevant credit, the tax is or would be assessed as payable by way of
income tax.
(8) In paragraph (7), “relevant credit” means—
(a)a payment made under section 59A of TMA (payments on account of income tax)
or 59B(7) (payment of income tax and capital gains tax); or
(b)tax deducted at source or tax treated as deducted (within the meaning given by
regulation 185(6)).
Recovery from employee of tax that has been self-assessed etc.
72F.—(1) Where this regulation applies, HMRC may direct that the employer is not
liable to pay an amount of tax to them.
(2) The direction may be in respect of one or more amounts that appear to HMRC to
fall within regulation 72E(1)(b)(i) and (ii).
(3) A direction must be made by notice to both the employer and the employee,
stating—
(a)the date the notice was issued;
(b)the amount (or amounts) within regulation 72E(1)(b) to which it relates; and
(c)which of conditions A, B and C in regulation 72E have been met.
(4) A direction may be combined with one or more other directions relating to the
same employer and may be made by issuing one notice to the employer, but each
employee must be issued with a separate notice.
(5) A notice need not be issued to the employee if neither HMRC nor the employer
are aware of the employee’s address or last known address.
(6) The amount specified in a notice to the employee must not be added under
regulation 185(5) or 188(3)(a) (adjustments to total net tax deducted for self-
assessments and other assessments) in relation to the employee.
Employee’s appeal against a direction notice
72G.—(1) An employee may appeal against a direction notice under regulation 72F—
(a)by notice to HMRC,
(b)within 30 days of the issue of the direction notice,
(c)specifying the grounds of the appeal.
(2) For the purposes of paragraph (1) the grounds of appeal are that—
(a)the employee did not receive a relevant payment;
(b)the amount specified in the notice is incorrect, because all or part of it did not fall
within regulation 72E(1)(b)(i) or (ii);
(c)no trigger event within regulation 72E(5) occurred; or
(d)a trigger event within regulation 72E(5) occurred before 6th April 2008.
(3) On an appeal under paragraph (1) the Commissioners may—
(a)if it appears to them that the direction should not have been made, set aside the
direction; or
(b)if it appears to them that the amount specified in the notice is incorrect, increase or
reduce the amount accordingly.”.