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The term “Service Company” is causing much confusion of late – most of which – maybe all – we can attribute to HMRC.

At law a “Service company” is not defined. Never has been.

Many years ago a “service company” was something which may be used by a lawyers, accountants, doctors, dentists and other professions denied corporate status to give them some of the advantages of corporate status. It was also a term used in the property world for a company managing a shared property, eg a block of flats.

In the last decade, with IR35 being the new kid on the block and, latterly, the MSC legislation, “service company” has taken on a new colloquial meaning aka “personal service company”.

For some years the annual P35 employers return has had questions on it about IR35 / service companies.

This last year, HMRC have changed those questions and added some new ones onto individual Self Assessment returns as well.

P35 EMPLOYERS RETURN

2007-08 was the first year of operation for the new MSC (managed service company) rules, and its logical that HMRC need to police these.

The questions on P35 for 2007-08 were:

(i) “Are you a Service Company?” No/Yes

(ii) If ‘Yes’, have you operated the Intermediaries legislation (sometimes known as IR35) or the Managed Service Companies legislation? No / Yes

Two problems here. First, there is no legal definition of service company. How can you be a service company if there is no definition in law of one? In practice we know what they mean, and there is a definition of sorts in HMRCs payroll manuals, but thats no substitute for properly drafted rules and questions. Put that another way, ask a silly question, get a silly answer.

The second problem, have you operated the legislation? Well, the answer could be yes regardless. Take IR35 as an example; basically the legalisation is in three parts – first it frames those who it potentially applies to, secondly it sets out (badly) the criteria for the deemed salary applying and, thirdly it sets out the calculation of the deemed salary. Now suppose you have had a contract review, considered your status, taken advice, and decided that the IR35 deemed salary rules don’t apply to you – if so have you operated the legislation or not? Well, you’ve certainly operated the first and second part, and the answer to the second part was you didn’t need to go on to part three. So, “Yes” or “No”. Well, we know what HMRC were really asking – about part three – but, again, they didn’t ask it properly. SO you can easily answer “Yes” I operated the legislation in the correct manner for someone it doesn’t apply to.

HMRC have, belatedly, realised the folly of their ways. In a recent update they have indicated they are going to ignore the answers to these questions for the purposes of rick profiling this tax year (although one may argue if you believe that, you’ll believe anything).

The conclusion here is that HMRC are fishing for infomration about those whom IR35 or the MSC legilsation applies to. Although some of HMRCs questions are badly worded, the net is closing – there is no way aroound this legilsation, just a way through it, which is making sure you work in a IR35 complient manner (and thats much more than just a fancy contract – its the working practices on a day to day basis that carry weight). Fancy contracts, fancy tax schemes – be they MSCs, offshore, EBTs, or whatever – don’t succeed.

SELF ASSESSMENT RETURN

Moving on to the 207-08 Self Assessment return, we have a new question as follows:

“Total amount of income included anywhere on this Tax Return, derived from the provision of your services through a service company”

The tax return guide published by HMRC expands on this:

“You should complete this box if you have received any form of income (including employment income and dividends) during the year in question from a company through which you provided your services personally and of which you are a sole or joint shareholder.

“Complete this box if the company’s income is derived:

• wholly or mainly from services provided to third parties by you personally, or

• wholly or mainly from services provided to third parties by you personally and

your fellow shareholders and your shareholding is directly linked to the level of

company profit you generate (that is, linked to the amount paid by third parties

in respect of your personal services).

“Do not complete this box if you are a shareholder and company officer of a company and the company’s income is derived wholly or mainly from the provision of the services of company employees whose total income is treated as employment income, or derived wholly or mainly from the manufacture/provision of goods.

“Example

“Employment income (box 1 on the Employment page)

all received from the company £15,000

Dividends from UK companies (box 3 on page TR 3) of

which £50,000 was received from the service company

and £5,000 from a shares portfolio = £55,000

Total £70,000

Amount to be entered (excluding shares portfolio) in the

the service companies box, box 1 on page TR 4 £65,000”

This question is much wider than the P35 questions for IR35 / MSC and as much as it applies to “traditional” target areas, eg freelanceers in engineering, IT, and similar, it could apply to anyone (i) operating a company and (ii) not emplying others – a accountant, a graphic designer, a plumber and so on.

So HMRC are looking at something different here – almost certainly trying to root out those where the Income Shifting legislation may apply. You will probably recall that the Income Shifting legilsation (son of S660a) was meant to take effect this April, but its now been deferred for 12 months.

Again similar problems apply to the P35 – a service company isn’t defined in law for starters. More sigifincantly the quesions are subective – how much assistance do you need before you cease to supply services “wholly or mainly” by you perosnally – one part time assistant, one full time assistant, one part time fee earner? Wheres the line.

Similar comments apply though to those about the P35 – the net is closing. It looks like the Income Shifting legislation will apply in one form or another from April 2009 onwards, and its only to be expected that HMRC will seek to taret their enquiry resources into the direction where they feel they can have most impact.