Personal service companies: introduction of IR35

In the 1999 Budget the Labour Government announced that new rules would be introduced in the tax treatment of personal service companies (PSCs), to prevent the exploitation of this corporate structure as a means to avoid tax. These rules are usually called IR35, after the number of the Budget press notice which covered this change. Individuals working in a number of fields - Information Technology (IT) in particular - often set themselves up as a PSC, providing their services as a consultant to a client, rather than, say, working directly for that client on their payroll as their employee. The client pays the service company for the work they have done, without deducting income tax or National Insurance contributions (NICs) under PAYE.

There are several potential tax advantages to this type of arrangement: first, the range of expenses which the PSC may set against its taxable profits will be much wider than that allowed an employee to set against his taxable income. Second, there will be a cashflow benefit in avoiding tax being deducted at source each month. Third, the individual may be in a position to receive dividends out of their service company, as an alternative to only being paid a salary, an arrangement which is likely to mitigate their liability to NICs.

Following a long and contentious consultation exercise, provisions were introduced in the Finance Act 2000, and came into effect from 6 April 2000. In brief, the off-payroll working rules cover any engagement where an individual provides services under a contract between a client and an intermediary and, but for the presence of the intermediary, that person would be considered the client’s employee for tax purposes. In these cases, the intermediary is required to account for tax on the payment made by the client in the same way as employee earnings.[1]

This note gives some background to the use of personal service companies to avoid tax, before discussing the introduction of IR35 and its first years of operation.

Although IR35 has remained controversial in the twenty years since it was first announced, and many stakeholders have made the case for the regime to be scrapped, the rules have remained on the statute books. In the 2016 Budget the then Chancellor George Osborne announced that from April 2017 public sector bodies would have new duty to ensure any contractors that they took on were complying with IR35.[2] At the time Ministers ruled out introducing a similar duty on the private sector.[3] However, in the Autumn 2017 Budget the Government announced that in 2018 it would “carefully consult on how to tackle non-compliance in the private sector, drawing on the experience of the public sector reforms.”[4] A consultation was launched on 18 May, which closed on 10 August.[5] To date no further announcements as to potential reforms to IR35 have been made.[6] A second note discusses these developments.[7]

Notes :

[1] Detailed guidance on the rules is on HM Revenue & Customs’ site.

[2] HC Deb 16 March 2016 c956. see also, Budget 2016, HC901 March 2016 p43; HMRC, Off-payroll working in the public sector, March 2016

[3] Off-payroll working in the public sector: reform of the intermediaries legislation, May 2016 pp36-8

[4] Autumn Budget 2017, HC 587, November 2017 para 3.7

[5] HM Treasury press notice, Government to consult on tax avoidance in the private sector, 18 May 2018

[6] See PQ167869, 5 September 2018

[7] Personal service companies and IR35, CBP5976, 6 September 2018.