Tackling Managed Service Companies and Managed Service Companies: Transfer of Pay as You Earn and national insurance contributions debts

Transcription

1 Tackling Managed Service Companies and Managed Service Companies: Transfer of Pay as You Earn and national insurance contributions debts Response of the Income Tax Sub-Committee of the Law Society of England and Wales March 2007

2 Contents 1. Introduction General comments The application of the existing IR35 legislation The relevance of employment-rights concerns The persons to whom PAYE and NICs debts of MSCs may be transferred Answers to the consultation questions Response to Tackling Managed Service Companies Response to Managed Service Companies Transfer of Pay as You Earn and national insurance contributions debts... 7 i

3 Tackling Managed Service Companies and Managed Service Companies: Transfer of Pay as You Earn and national insurance contributions debts Response of the Income Tax Sub-Committee of the Law Society of England and Wales 1. Introduction This response has been prepared by the Law Society, the representative body for more than 100,000 solicitors in England and Wales. The Society negotiates on behalf of the profession and lobbies regulators, government and others. The Law Society welcomes the opportunity to comment on two consultation papers issued jointly by HM Treasury and HM Revenue & Customs ( HMRC ), Tackling Managed Service Companies (December 2006), and Managed Service Companies Transfer of Pay as You Earn and national insurance contributions debts (February 2007). We set out below a number of general comments on the proposed regime for managed service companies ( MSCs ) followed by our views on the specific consultation questions raised in each document. 2. General comments The Law Society makes a number of general comments on the proposed legislation. 2.1 The application of the existing IR35 legislation The Law Society notes the Government s concern expressed in Tackling Managed Service Companies that MSCs are used to disguise the true nature of an employment relationship by purporting to provide the services of workers through an intermediary company. We also note the Government s evidence that such a use of MSCs causes a loss to the Exchequer of tax and NICs revenue. However, as the Government acknowledges at paragraph 2.38 of Tackling Managed Service Companies, MSCs fall within the scope of the existing legislation which applies to services provided through an intermediary (Chapter 8 of Part 2 of the Income Tax (Earnings and Pensions) Act ( ITEPA ) 2003, described hereafter as IR35 ). So, there is already a legislative mechanism for taxing as employment income payments to workers provided through a MSC scheme. The problem, as stated at paragraphs 2.40 to 2.45, is that MSC scheme providers are not complying with the existing legislation. HMRC is experiencing administrative difficulties in applying IR35 to MSCs, and where the legislation is applied, HMRC is finding it difficult to enforce liabilities against particular MSCs as they are often wound-up and quickly restarted in a different legal entity, leaving no assets in the original MSC against which the debt can be enforced. The Law Society believes that it is inappropriate as a matter of policy to attempt to solve non-compliance with IR35 (or indeed with any other area of tax law), and difficulties of enforcing IR35 against MSCs, by imposing a new set of charging provisions on MSCs and creating the power to transfer these liabilities to third parties. It is only with great reluctance 1

4 that one person s tax liability should be imposed on another person, and we do not agree that HMRC s compliance and enforcement difficulties are sufficient justification to do so in this case. We believe that the better approach would have been to continue with attempts to enforce the application of IR35 on MSCs. Where MSC scheme providers cause the MSC s liability to be evaded by liquidating the MSC, we believe the appropriate approach would be for HMRC to use its existing powers of criminal prosecution against the scheme providers (for example, under the common law offence of cheating the public revenue, or the statutory offence of fraudulent evasion of income tax). Such an approach would likely serve as an effective deterrent to those scheme providers seeking to evade compliance with IR35. It may be appropriate to consult on changes to the regime in IR35 to enable better enforcement of its provisions. Ultimately problems of tax collection in this area lie with the fundamental difference between the self-employed and the employed. If this distinction is accepted then IR 35 should be the method of collecting tax in respect of arrangements which involve an employment relationship and an intermediary vehicle. We believe the introduction of the MSC proposals brings up certain issues that require consideration. The first is that there has to be flexible and effective outsourcing of labour and services in the UK. This is against the background of fairly rigorous employment legislation. The consultation in December 2006 demonstrates that HMRC are aware of the complications that can arise as a result. In broad terms most entities which provide outsourcing services will be treated as employment businesses in order that they can operate PAYE to relieve clients of this burden and to ensure the employees are theirs and not their clients. It is important that so far as possible no greater hurdles are placed in the way of legitimate businesses operating in this area -- and those businesses might have several categories of engagement, including, for example, straightforward employees and self-employed workers who are treated as agents for the purposes of the PAYE regulations and who therefore have PAYE and NI deducted from amounts paid to them. As currently drafted there is no safe haven in the rules for such entities even though they might be operating perfectly properly. We comment on this further below but would suggest that some sort of safe haven is introduced for these entities if the rules are taken forward. (As an aside we would also point out that the VAT treatment of outsourcing is undergoing a review which could have, ultimately, adverse consequences for outsourcing by VAT exempt businesses; this potentially compounds the difficulties). The second, which follows on from the first, is that, as commented on below, it will be very difficult for advisers to give an opinion or not as to whether a personal service company does or does not fall within the MSC legislation, particularly where the administration of the PSC is contracted out to someone else. Both these rules lead to the need for some sort of safe haven or clearance procedure which, without blunting the rules that are introduced, allows the properly run business to carry on as before. 2.2 The relevance of employment-rights concerns The Law Society notes the Government s concerns (expressed at paragraphs 2.34 to 2.37 of Tackling Managed Service Companies) that the use of MSCs to provide the services of workers to clients may deny those workers the rights to which they would otherwise have been entitled under an employment relationship. However, the Law Society does not consider the protection of employment rights is a matter for HM Treasury or HMRC, nor that amendments to tax legislation are an appropriate mechanism for securing the protection of employment rights. As a question of policy, these changes should be secured by changes to employment law. 2

5 2.3 The persons to whom PAYE and NICs debts of MSCs may be transferred Notwithstanding the above comments, we acknowledge that the Government is likely to continue with the proposals outlined in the two consultation papers, and the remainder of the Law Society s comments proceed on this basis. The Law Society is particularly concerned by the proposals regarding transfer of PAYE and NICs debts of MSCs, as set out in Managed Service Companies Transfer of Pay as You Earn and national insurance contributions debts. We have two broad policy concerns which are outlined in this section. Our technical comments on the proposed measures are outlined in response to the specific consultation questions. 2.3(i) The width of the range of persons to whom debts may be transferred As we understand the draft legislation, once HMRC concludes that a relevant PAYE debt is irrecoverable from a MSC, it may by direction authorise the recovery of that debt from all of the persons specified in s.688a(2). It may then issue a transfer notice to recover that debt from a director, office-holder or associate of the MSC, or the scheme provider, requiring nothing more for liability than that the person falls into one of those categories. If that is impossible, impracticable, or protection of the Exchequer would be prejudiced, then it is also possible to serve notice of liability on a person who encouraged, facilitated or was otherwise involved in the provision of the worker s services through the MSC, or a director, office holder or associate of such a person or of the scheme provider. The Law Society considers as a matter of policy that the range of persons to whom debts may be transferred is too wide and consequently may operate in an unjust manner. We consider that HMRC should have powers to hold liable for the PAYE debts of an MSC only persons who HMRC can prove were responsible for the promotion or operation of the MSC scheme, or for the encouragement or facilitation of the provision of workers by an MSC, and not simply every person associated with the MSC or the scheme provider. In brief, we consider the number of persons who could be made liable is too wide. For example, we cannot see how an individual associate of an individual controller or of a partner or member of a partnership is relevant surely it is an accident if you are the relative of a tax avoider, rather than a determinant of liability. The same point arises in relation to associates of facilitators or those who have encouraged (a rather wide and far too imprecise a term for attaching liability), or been involved in, the provision. This seems to us to be simply too wide, and so wide that it may have Human Rights implications. Surely the persons that HMRC are after are organisations under common control with the MSC, controllers of the MSC, and organising or managing persons who are in receipt of the profits of the MSC operation. We address the specific technical amendments necessary to give effect to this approach in our response to the specific consultation questions. 2.3(ii) The onus of proving responsibility for the promotion or operation of the MSC The second policy concern links to the first. As presently drafted, HMRC is permitted to collect tax on the basis of guilt by association. For no more than being involved with or associated with a MSC or a scheme provider, a person may be liable for the irrecoverable debts of that MSC. The proposal is that it is not for HMRC to prove a person s guilt in this regard, a person is liable simply for having been involved and must successfully appeal in order to disapply that liability. 3

6 Given that the proposed power is able to extend liability for MSC debts to such a wide range individuals, we consider that as a question of general policy the onus should be on HMRC to prove a person s responsibility for the promotion or operation of the MSC scheme, at the time of serving the notice of liability on that person. We address the specific technical amendments necessary to give effect to this approach in our response to the specific consultation questions. 3. Answers to the consultation questions 3.1 Response to Tackling Managed Service Companies We set out below the Law Society s response to the consultation questions contained in the consultation document Tackling Managed Service Companies : Question 3.14: The Government would welcome views on the scope of the draft legislation and, in particular, whether there are other defining characteristics of MSCs that should be reflected in the legislation. In general, we believe that the definition in s.61b incorporates the primary characteristics of a managed service company. However, we have a number of comments on the drafting: (1) We note that the definition is a cumulative one, requiring each of the four conditions in section 61B(1)(a), and section 61(B)(2)(a), (b) and (c) to be satisfied before a company is a managed service company. It therefore appears possible for an MSC to avoid satisfying the definition merely by structuring its business so as to fall outside one of the four conditions. (We discuss further in our response to question 3.16 the methods by which this would appear possible). (2) We are concerned about the lack of a definition of control for the purposes of section 61B(2)(c). This concept of who controls an MSC is key to the Government s definition of an MSC, and it is therefore unacceptable to allow the term to remain undefined. While we agree, to an extent, with the comments in Box 3.2 that the definitions in sections 416 and 839 of the Income and Corporation Taxes Act ( ICTA ) 1988 would not be appropriate for these purposes, we would encourage the Government to introduce a statutory definition for the purposes of section 61B (see further our comments in response to question 3.15). (3) We are also concerned about the possibility of legitimate personal service companies (PSCs) falling within the new MSCs legislation and not the existing IR35 provisions. Almost every PSC would satisfy conditions 61(B)(1)(a), 61(B)(2)(a) and 61(B)(2)(b). The only distinguishing condition, as is acknowledged in the commentary at Box 3.2 of Tackling Managed Service Companies, is that the workers in an MSC do not exercise control. However, because the term control remains undefined, it would at present be difficult for a solicitor to advise a worker using a PSC as to whether he or she would fall within the MSC legislation, particularly where the administration of the PSC is contracted-out by the worker. 4

7 Question 3.15: The Government is keen to keep the legislation as simple as possible so that people can make their own judgments as to whether their business arrangements meet the criteria for being defined as an MSC or not. There will be additional guidance to assist the lay reader. The Government would welcome views on the clarity of the legislation. As mentioned in the answer to question 3.14, we would welcome a statutory definition (or other authoritative guidance) on the meaning of control for the purposes of section 61B(2)(c). The scheme provider s control of the MSC, and the worker s lack of control of the MSC, are the defining characteristic of a managed service company. The Law Society considers that without a clear definition, it will be difficult for solicitors or other professional advisers to give accurate advice on the application of the legislation to an intermediary scheme. While we accept that the section 416 and 839 definitions in ICTA 1988 may not be appropriate for these purposes, we nevertheless consider that the draft legislation lacks clarity without a definition of the term. Paragraph 3.5 of Tackling Managed Service Companies provides what the Law Society considers to be a useful description of what is meant by financial and management control. The Law Society encourages the Government to incorporate these features into the legislation so as to provide greater certainty both to professional advisers and the providers of legitimate intermediary schemes. It may be worth for the purposes of the definition of control considering section 840 ICTA 1988 rather than section 416. Section 416 essentially looks at shareholder control, whereas 61B(2)(c) is looking at control more in the sense of the central, director level, management of the MSC and how it operates. It may be worth considering whether section 840 could be adapted so that the controller is the person (or persons acting together) who can ensure that the MSC acts in accordance with its wishes, or in relation to more sophisticated management structures, the person on the basis of whose advice the MSC is accustomed to act and whose fees represent a significant proportion of profits (excluding professionals acting purely in an advisory capacity). As an additional point, it is unclear if the reference at section 61B(2)(b) to the greater part of the consideration being paid to the individuals is deemed to include payments of employment income under a contract of employment (if any) between the MSC and the worker? We assume that such payments are intended to be included (or else the MSC could avoid the application of this condition merely by assigning a greater part of the consideration between both its own fee and employment remuneration to the worker), and we accordingly suggest that the following is inserted in section 61B(2)(b) after the word indirectly in the parentheses:, including but not limited to payments in the form of employment income. Question 3.16: At the same time, it is important that the legislation should be robust against attempts to circumvent it by re-structuring or devising new arrangements purporting to be outside its scope. The Government would therefore welcome views on whether the legislation could be strengthened further and, if so, how. We have a number of concerns about how MSCs could seek to avoid the application to them of the new statutory definition of a managed service company. We consider that the Government may wish to address these possibilities in any redrafting of the legislation, and a failure to do so could leave open the use by MSCs of structures falling outside of the legislation: (1) As noted in response to question 3.14, we consider that the cumulative definition of a managed service company is open to avoidance via MSCs restructuring their business so as not to satisfy one of the four conditions. In particular, we observe that the 5

8 following conditions may be vulnerable to restructuring by MSCs: 61B(2)(b) this condition could be avoided if the greater part of the consideration for the services is not paid to the individuals. For example, the greater part of the consideration could be retained as a fee by the scheme provider (or, as a variation, the consideration could be artificially inflated so that the greater part of it is paid to the scheme provider and not the workers, with a mechanism to repay the inflated part of the consideration back to the client, perhaps by way of dividend or as fees for a purported service provided by the client to the scheme provider); or 61B(2)(c) this condition could be avoided if either the scheme provider relinquishes control of the MSC or the workers are granted control over the MSC. This could be facilitated by requiring the workers to be (nominally, at least) directors and controlling shareholders of the MSC, with the scheme provider acting (again, nominally) as professional adviser or consultant to the MSC. (2) While we note the Government s decision to include all bodies corporate and partnerships (including LLPs) within the definition of company in section 61B(3), there are other structures or entities which may not satisfy this definition and could potentially be utilised by MSC providers to avoid the legislation. In particular, we consider that if a MSC was operated with an (ostensibly) discretionary trust as the shareholder, of which the worker was the beneficiary, dividend payments to that trust could not be treated as payments to a worker or his associate (given that section 417(3)(b) ICTA 1988 does not include payments to trusts of which the worker is a beneficiary but not a settlor). The trust could later make discretionary distributions to the worker avoiding PAYE and NICs liability. We would therefore suggest that the following is added to the end of clause 61B(2)(b), before the word and : or to a trust of which the worker is a beneficiary,. (3) There is no ability for any entity which does not fall within IR35, but which carries on a properly run business activity to fall outside the definition of MSC. For example, if a company carries on an employment business and provides self-employed individuals to third parties, managing their provision and deducting PAYE and NI under the PAYE agency provisions from sums paid to them, this entity is nevertheless an MSC and has to consider the remaining provisions which apply. Is there any scope for an exclusion which applies where all amounts received by the individuals are either brought into account as employment income (from which PAYE and NI is deducted) or as the profits of a trade or profession (subject in either case to deductions properly allowed under those provisions)? This still does not cover distributions from organisations to employee shareholders, so some sort of additional approval system on the basis of criteria specified by HMRC might be necessary. Question 4.11: Government would welcome comments on the draft legislation on the tax charging provisions, including treatment of expenses, at Annex B this is supplemented by detailed explanation of the clauses at Annex C. The Law Society broadly agrees with the proposed tax charging provisions, subject only to the minor comments which follow: (1) We consider that section 61D(1), Step 1, could be clarified by specifically excluding from the calculation any amounts paid to the worker as employment income subject to PAYE and NICs. Although such payments are separately stated in section 61C(1)(c), they are not expressly excluded from section 61C(1)(b) for the purposes of Step 1. We 6

9 accordingly suggest Step 1 could be amended by adding the following text at the end of the sentence before the full stop:, excluding any payment mentioned in section 61C(1)(c). (2) In section 61D(1), the wording of Step 3 is slightly ambiguous and open to potential confusion. It may be more helpful to specify that the result of Step 2 represents an amount: which equals the sum of both (i) a payment of employment income and (ii) employer s national insurance contributions on that payment. Question 4.20: The Government aims to publish draft legislation covering the transfer of debt by the end of January The Government would welcome comments in the intervening period. The Law Society s comments on the draft transfer of debt legislation are set out below in our response to the consultation paper on this subject. 3.2 Response to Managed Service Companies Transfer of Pay as You Earn and national insurance contributions debts We set out below the Law Society s response to the consultation questions contained in the consultation document Managed Service Companies Transfer of Pay as You Earn and national insurance contributions debts : Question 1.27: The Government is consulting to ensure that it gets the balance of the legislation right and would welcome other formulations which achieve its objectives. Please see above at paragraph 2.3 our general comments in respect of the balance of this legislation. Our technical comments on the balance of the legislation are set out below and in particular the Law Society welcomes the opportunity to suggest other formulations which may achieve the Government s objectives. Regulation 97B 97B(1)(a): we agree that a necessary condition for the transfer of a debt is establishing that a MSC has a relevant PAYE debt. We agree with the drafting of the five formulations of PAYE debt (conditions A to E) at reg. 97C. 97B(1)(b): while we agree that a further necessary condition for the transfer of the debt is that it is irrecoverable, we are concerned by the lack of definition or guidance as to the meaning of this term, and encourage Government to include a clear definition within the legislation. This is necessary both to ensure that the legislation is consistently and fairly applied, and to enable professional advisers and persons to whom debt may be transferred to assess with accuracy any potential liability under the legislation. As a suggested approach, we recommend that HMRC should be required to send the MSC a warning notice stating that: the MSC has a relevant PAYE debt; if such debt is not paid in full within a prescribed number of days (for example, 14 days), HMRC will consider the debt to be irrecoverable; and once the debt is considered to be irrecoverable, HMRC will exercise its powers under section 688A to transfer the relevant PAYE debt to the persons listed in section 688A. 7

10 97B(2) (4): we do not agree with the two-stage approach outlined here of firstly making a direction authorising the recovery of the PAYE debt from all of the persons specified in section 688A and secondly issuing a transfer notice against particular individuals to transfer the debt (or a lesser portion of the debt) to them. Although we do agree that a transfer notice must be served on persons who are to be made liable, we do not consider the first step to be a proportionate one. We would prefer to see an approach where HMRC initially established a complete list of all of the persons that it considered to be responsible for the PAYE debts of the MSC (either on the basis that they were responsible for the promotion or management of the MSC scheme or the operation of the scheme provider, or because of their encouragement or facilitation of the provision of the services of MSC workers to end clients) and then served a transfer notice only on those persons. If a person was not responsible for the PAYE debts of the MSC on this basis, HMRC should not be entitled to establish that person as liable for the PAYE debts. In this regard, we consider the test outlined in regulation 97B(7) to be a useful starting point for such a definition. However, we would suggested adding a reference to responsibility for operating the managed service company scheme or scheme provider, and removing the reference to being otherwise involved in the encouragement or facilitation of the provision of the services of individual workers. We accordingly propose amending regulation 97B(2) to read as follows (with suggested additions highlighted in bold): (2)(a) HM Revenue and Customs may make a direction authorising the recovery of the specified amount from such of the persons specified in section 688A(2) (managed service companies: recovery from other persons) that are certified by the Board of HM Revenue and Customs as being responsible for the relevant PAYE debt of the managed service company. (b) A person is responsible for the relevant PAYE debt of a managed service company for the purposes of regulation 97B(2)(a) if: (i) that person was responsible for the management, operation or promotion of the managed service company scheme or the scheme provider; or (ii) that person arranged or facilitated the provision by the managed service company of the services of an individual to another party. We consider that adopting such a definition would enable the legislation to accord with what ought to be the ultimate objective of this initiative (to make persons who are responsible for MSCs or their operation liable for the unpaid PAYE debts of those MSCs) and not to make any person who happened to be involved with or associated with a scheme responsible for the PAYE debts. In particular this would avoid a situation where innocent parties are held liable for PAYE debts, such as workers who are pressured into becoming directors of MSCs, without understanding the implications of accepting this position. (We would be grateful if consideration could be given to the replacement of the work encourage in section 688A(2) with something such as arrange we believe that encourage does not have a sufficient nexus with the activity). 97B(6): We agree that the persons mentioned in section 688A(2)(c) should be liable for a relevant PAYE debt only as a secondary layer of liability once all of the possibilities of 8

11 transferring liability to persons in paragraphs (a) and (b) (the first layer ) have been exhausted. However, we would expect this treatment to have been extended to the persons specified in section 688A(2)(d) as well as (c), and therefore encourage the Government to amend regulation 97B(6) (and to the extent consequentially necessary, 97B(7)), to refer to the persons mentioned in section 688A(2)(d) as well as (c). Further, although we approve of the general approach of not transferring liability to the secondary layer of persons until the possibility of recovery from the first layer has been exhausted, we do not agree with the technical drafting of particularly 97B(6)(b) and (c). It would appear arbitrary and unjust to transfer a PAYE debt to a person in the secondary layer, simply because it is impracticable to recover from the first layer, or because the time limits for recovery from the first layer are close to expiry. We would suggest limiting recovery from the second layer to the impossible situation provided for in regulation 97B(6)(a). 97B(7): We recommend that the reference to otherwise been involved in is deleted, as this is potentially vague and arbitrary in its application. Regulations 97C and 97D We agree with the suggested drafting of the definition of a relevant PAYE debt in regulation 97C. The suggested time limit of 12 months for serving a transfer notice provided for in regulation 97D appears appropriate. Regulation 97E We agree that a transfer notice should contain all of the information stated in regulation 97E. However, we consider that a transfer notice should contain additional information, to accord with our policy concern that the onus of proof should be on HMRC to establish why and how a particular person is responsible for the PAYE debts of an MSC. We consider that the grounds of appeal stated in regulation 97G are a useful template for this additional information requirement. For each of the grounds of appeal listed in regulation 97G(3)(a) to (l), we consider that the onus should be on HMRC to set out in the transfer notice why each of these grounds of appeal is not satisfied (i.e. why the person is liable). For example, it should be HMRC s responsibility to show that: the relevant PAYE debt is due from the MSC to HMRC (referring to ground of appeal (a)); the specified amount does relate to a company which satisfies the definition of a managed service company, and how this definition is satisfied (referring to ground of appeal (b)); and so on, through each ground of appeal in turn. We encourage the Government to amend regulation 97E to include a description of how all of the steps to liability are satisfied, mirroring the grounds of appeal in regulation 97G. Regulation 97F This regulation appears appropriate. 9

12 Regulation 97G To the extent that the Government includes our suggested amendments to the conditions for liability in regulation 97B, as outlined above, we recommend the Government includes at regulation 97G consequential amendments to include as grounds of appeal that these conditions have not been satisfied. For example, were the Government to amend regulation 97B(2)(a) to include the Law Society s suggestion that only persons who are certified by an officer of HM Revenue and Customs as being responsible for the relevant PAYE debt of the managed service company may have a PAYE debt transferred to them, it should be a new ground of appeal in regulation 97G that the person served with the transfer notice is not so responsible. Regulations 97H 97L These regulations appear appropriate, subject to one comment. In regulation 97H, where the Special Commissioners have the power to reduce or increase an amount of liability as is just and reasonable, it would increase transparency if they were required to provide written reasons as to why any increase or reduction is just and reasonable. Question 1.28(1): The Government would welcome views on whether the legislation brings within its scope all of those potentially involved in the provision of a worker s services by the MSC and ensure that those simply receiving the services of MSC workers are not included The Law Society s views on the appropriateness of persons liable to have an MSC s PAYE debts transferred to them are set out above in response to question As noted there, the Law Society considers that the range of persons who may be held liable, and the procedure for transferring liability to them, does not accord with what ought to be the underlying policy of this legislation. We have proposed a number of amendments to the draft regulations, set out above, which would limit the persons to whom PAYE debts may be transferred only to those persons who were responsible for the management, operation or promotion of the managed service company scheme or the scheme provider, or who encouraged or facilitated the provision by the managed service company of the services of an individual to another party. We consider that adopting this approach would ensure that only those persons responsible for the provision of a worker s services were caught by the legislation, and would clearly exclude those innocently receiving the services of MSC workers. Question 1.28(2): The Government would welcome views on whether there are alternative ways to encapsulate in the legislation that a person such as an agency or end client would not be within its scope if they did not know or could not reasonably have been expected to know that they were dealing with an MSC. The Law Society believes that there are alternative ways to encapsulate this position, and has set out its views in the answers to questions 1.27 and 1.28 part (1), above. 8 March