The government announced in Budget 2012 that measures would be introduced to tackle avoidance through the use of personal service companies. It was also announced that there would be consultation on legislation requiring 'controlling persons' who are integral to the running of an organisation to have PAYE and NIC deducted at source by the organisation by which they are engaged. The intention is to introduce these new rules in Finance Bill 2013. No one seemed very sure at the time exactly what this announcement meant, or why the new measures were being proposed.
However, in May 2012 the Treasury published a document entitled ‘Review of the tax arrangements of public sector appointees’, and the chief secretary to the Treasury, Danny Alexander, made a statement to the House of Commons on the subject. The Treasury review found that over 2,400 key people in central government departments were paid 'off-payroll' to personal service companies, employment agencies and individuals directly, in some cases for more than 10 years. The government announced proposals aimed at those engaged in central government departments etc to stop this from happening again, other than in exceptional circumstances. It was recommended that the most senior public sector staff should be on the payroll, and that government departments should have the right to seek assurances in relation to the tax arrangements of long-term contractors.
On 23 May 2012, the Treasury and HMRC published a consultation document entitled ‘The taxation of controlling persons’. The document points out that controlling persons can be engaged through a variety of intermediaries including partnerships and LLPs, but the main focus of the consultation document is on personal service companies.
There are two important points to note about these proposals. Firstly, if the rules about controlling persons are introduced, they will not replace the IR35 provisions for payments to intermediaries. Those provisions will remain in place as before. However, the controlling persons rules would take precedence over other statutory rules such as IR35, and also the legislation in ITEPA 2003 dealing with agency workers. Secondly, although the Treasury review mentioned above was focused on public sector appointees, the proposed new rules on controlling persons will affect both public and private sector workers. In other words, the government has taken the opportunity to extend the scope of the new rules to businesses in general. However, there is a proposed exception for small businesses (see below).
How will the new rules on ‘controlling persons’ work? The draft legislation has yet to be published, so the precise details are unclear. However, in broad terms if an individual is a controlling person, the business or organisation that engages that individual will be required to place him or her on the payroll. If the individual has a personal service company, there would still be an obligation for PAYE and NIC to be deducted by the engaging business or organisation, even if the payments are made to the personal service company. The payroll deductions would broadly be the same as if the individual was an employee, which means that employers’ NIC would be payable as well. Presumably, there will also be rules preventing double taxation, such as where the payments are made to a personal service company, although we must wait for the legislation to see how all this will work in practice.
The key question for the purposes of the proposed rules will therefore be: ‘is the individual a controlling person?’ Will there be a statutory definition of ‘controlling person’ for these purposes? Once again we must wait for the legislation. However, the consultation document states that a controlling person will be as follows:
“someone who is able to shape the direction of the organisation having authority or responsibility for directing or controlling the major activities of the engaging organisation during the year. This would be someone who has managerial control over a significant proportion of the organisation’s employees and/or control of a significant proportion of the budget of the organisation.”
This all seems rather vague. Terms such as ‘authority’, ‘responsibility’, ‘directing’ ‘controlling’ and ‘significant proportion’ really need to be defined. Unfortunately, the government’s and HMRC’s practice these days is often to interpret legislation in non-statutory form such as guidance notes, rather than defining terms in the legislation itself. Hopefully, that will not be the case when it comes to defining ‘controlling persons’.
There is a proposed ‘let out’ from the requirement to place controlling persons on the payroll, in the case of what the government refers to as ‘micro businesses’. These are businesses which employee fewer than 10 persons, and whose turnover and/or balance sheet total does not exceed 2 million Euro (approximately £1.7 million). However, this exception would not apply to micro businesses that are part of the group of companies. Another important point to note is that even if the controlling persons rules do not apply in respect of an individual engaged through a personal service company, the other statutory provisions such as IR35 would need to be considered instead.
There are a number of points to consider on the proposed rules on ‘controlling persons’, and also a number of questions which are left unanswered. For example, why are these rules needed if IR35 is being retained? Surely it would be easier to apply the IR35 rules properly? If an individual has control over the engaging business, would the individual not fall within IR35 anyway in most cases? This all begs the question whether those public sector workers mentioned above who operated through personal service companies were considered by HMRC to fall outside IR35, and if so, on what basis.
The consultation document states that the proposed rules are the most effective way to achieve the right level of ‘transparency’. What this probably means is that the government was rather embarrassed to find so many individuals engaged in the public sector to be ‘off payroll’, and in that sense the proposed rules would stop the problem from happening again. Of course, the new rules will also stop a potential loss of tax and NIC to the government, which is perhaps why the rules are being extended to the private sector.
With regard to the business or organisation that engages the individual, the requirement to deduct PAYE income tax and NIC at source means that it is likely to become more expensive to engage controlling persons than before, in the sense that there will be a requirement to account for employer’s NIC as well. A personal service company previously provided some protection from that requirement, but it seems that this protection will disappear. However, it would appear that although the individual would be taxed as an employee, he or she would not actually be an employee, and would therefore not have the employment rights of a normal employee, such as holiday and sick pay.
Finally, the fact that the rules on ‘controlling persons’ are subject to consultation and that no draft legislation has been published as yet suggests that it is by no means certain that the rules will be introduced, if for example the consultation reveals good reasons why the rules would be disproportionate or ineffective, or if a better solution can be found. Thus if the new rules are introduced, they may look rather different then the consultation document indicates.
Mark McLaughlin CTA (Fellow) ATT TEP