PAYE Year-end Procedures – Clarification of Question 6 of form P35Monday, May 25th, 2009
Question 6 in the Part 3 – Checklist section of the P35 Employer Annual Return is poorly worded and confusing. There are two parts to the question:
- Are you a Service Company?
- If ‘Yes’, have you operated the Intermediaries legislation (sometimes known as IR35) or the Managed Service Companies legislation?
Employers completing either a paper or online version of the P35 need to be able to identify whether they are a “Service Company” and, if so, whether they have applied one or other of the two sets of complex legislation that relates to service companies.
In a rather apologetic article, HMRC acknowledges that the questions and the manner in which the answers have been handled have caused confusion and inconvenience. It has not helped that, since the “IR35” service company legislation was introduced in 2000, the wording of Question 6 has changed almost every year. It is still far from clear.
There is a detailed explanation of the meaning of Question 6 on page 18 of the E10 Employer Helpbook Finishing the tax year up to 5 April 2009. HMRC accepts that a direct reference on the P35 to this E10 guidance would have caused less confusion and the problem will be addressed on next year’s P35. If there really is an intention to change the wording again on the 2009/10 version of the P35, it has to be done urgently as, in principle, businesses that are closing down already need to complete P14s and a P35 for 2009/10.
For readers who are not clear as to whether their business is a “Service Company”, booklet E10 defines it in this way:
“The first question should be answered yes if:
- an individual performed services (intellectual, manual or a mixture of the two) for a client or clients, and
- the services were provided under a contract between the client and the company of which, at any time during the tax year, the individual performing the services was a shareholder or partner, and
- the company’s income was, at any time during the tax year, derived wholly or mainly (that is, more than half of it) from the services performed by the shareholders or partners personally.
For the purposes of this question, ‘service company’ includes a limited company, a limited liability partnership, or a partnership.”
If an employer who actually understands that explanation answers “Yes” to it, the next problem is answering the second part of the question. It appears to be asking the employer to identify which one of two sets of legislation apply to the service company but, in fact, it is not. Rather, it is asking whether or not the service company has operated whichever of the sets of legislation applies to it.
Service companies that fall within the Managed Service Companies legislation are required to deduct PAYE tax and NICs from the earnings (less certain expenses) of their workers. As a result, the answer to the second part of the question must be “Yes”.
However, in the case of service companies that fall within the IR35 Intermediaries legislation, HMRC’s guidance is that the answer to the second part of the question may be “Yes” or “No”. In fact, HMRC’s article states that it will be “quite common for the first part to be answered ‘yes’ and the second part ‘no’.” The situation where the answer can be “No” is where none of the worker(s) involved would have had to have been treated as employees of the client if the contract had been made directly between the worker and the client instead of between the client and the “intermediary”, i.e. the service company. HMRC is taking the view that, in that situation, the IR35 rules do not apply to the service company, so the correct answer to the second part of the question is “No”.
The answer is “Yes” however if at least one of the workers would have had to have been treated as an employee in the circumstances described above and the service company either
- deducted PAYE and NICs from the payments made to the worker, less permitted expenses, at the time they were made, or
- did not make such deductions and, as a result, has a liability for PAYE and NICs on the “deemed payment” calculated at the end of the tax year.
All of this leads to a key issue that has led up to HMRC’s apology. According to guidance on page 78 of booklet CWG2 Employer Further Guide to PAYE and NICs, if a service company falling within IR35 rules is unable to calculate accurately the “deemed payment” by the P35 filing date, provisional figures may be entered on form P35 instead. In that situation, the service company must explain that the figures are provisional in a separate letter and provide accurate figures no later than the following 31 January.
It is clear, however, that, if the service company answers “Yes” to the second part of Question 6, that does not mean that the PAYE and NICs figures entered on the P35 are provisional. They may or may not be. In relation to the 2007/08 tax year, HMRC made the mistake of issuing reminders about providing final figures based on the answer “Yes” rather than because the service company had sent a separate explanatory letter.
For 2008/09 filing, HMRC has decided to drop the requirement to provide a covering letter if provisional figures are entered on the P35, despite the requirement to do so given in the 2009 CWG2. If the second part of Question 6 has been answered “Yes”, HMRC will write to the service company later in the year reminding them that, if their P35 figures were provisional, they must file an amendment P35 and make a balancing payment by 31 January. HMRC will assume, therefore, that if the original figures were provisional, the corrected figures will have been filed by 31 January.
Provisional figures: those employers to whom ‘IR35′ applies
The UK Payroll News is sponsored by HRD & Payroll Solutions