A joint HM Revenue & Customs/Treasury consultation has proposed that all "controlling persons", including in the private sector, should be placed “on payroll”. This is intended to apply regardless of whether the payments for that person’s services are made to the controlling person or to an intermediary, and will require the "engaging organisation" to operate PAYE and pay National Insurance contributions.
A joint HM Revenue & Customs (HMRC)/Treasury consultation (the consultation) has proposed that all "controlling persons", including in the private sector, should be placed "on payroll" (see box "Who is a controlling person?"). This is intended to apply regardless of whether the payments for that person's services are made to the controlling person or to an intermediary (for example, a personal service company), and will require the "engaging organisation" to operate PAYE and pay National Insurance contributions (NICs) in respect of such payments.
Where it applies, this will override the controversial IR35 legislation, shifting the obligation to operate PAYE/NICs from the personal service company to the engaging organisation. (IR35 is a rule to stop the avoidance of tax and NICs by using intermediaries, typically a personal service company owned by the "employee".)
The consultation is at an early stage, with the Finance Bill 2013 being the earliest that this legislation could be enacted.
Payments to employment businesses and employment agencies will be excluded from this regime, as will payments by micro-businesses.
On 31 January 2012, the Chief Secretary to the Treasury announced a review of the tax arrangements of public sector appointees (the review). This followed controversy over the use of personal service companies by certain individuals in the public sector. There were concerns that individuals were using these arrangements to minimise their tax payments. The review's aim was to examine the extent to which such arrangements were in place and to make recommendations as to what action should be taken.
The review's findings were published on 23 May 2012, and concluded that most senior staff should be on the payroll in all but exceptional, temporary, circumstances. It acknowledged that there are many circumstances in which it may be appropriate to engage an individual off payroll; however, it cited the employer's need for clarity and transparency that the individual is meeting his or her income tax and NICs obligations.
As a result, the review suggested prohibiting the use of intermediaries to engage certain senior staff in the public sector. The need for clarity and transparency also explains the other key recommendation of the review: that for other long-term engagements (that is, over six months, where more than £220 per day is paid), the department in question must have a right to assurance that income tax and NICs obligations are being met, and to terminate the engagement if that assurance is not received when sought.
Anyone who thought that the review only had implications for the public sector was mistaken. The consultation proposes more wide-ranging action; in particular, that all employers, including in the private sector, should operate PAYE and NICs in respect of all payments made for the services of controlling persons.
There have been previous legislative attempts to counter the use of personal service companies to engage individuals other than as an employee. The IR35 legislation, and the subsequent "managed service companies" legislation, have been the subject of much criticism and a number of court cases. Problems remain with this regime, which is being reviewed with the aim of improving its administration.
A key feature of the IR35 legislation is that, where it applies, the intermediary (for example, a personal service company) pays PAYE and NICs to HMRC, rather than the business (referred to in the legislation as the client), which pays the intermediary to provide the services of the individual (the worker) in question. This currently provides a degree of protection for businesses that contract with intermediaries. It is not unreasonable for a company to expect a person (for example, a non-executive director) who is sufficiently sophisticated to offer to provide services through an intermediary to ensure that he has complied with his tax obligations.
This protection will be removed if the change proposed by the consultation is made, at least in respect of controlling persons whose services are supplied through a personal service company or other intermediary (such as a partnership or LLP). The client business will have the obligation to operate PAYE and NICs.
The stated reason for imposing this obligation is the need for the client business to have assurance that its controlling persons have met their income tax and NICs obligations in a way which is transparent to it. This is the same reason as that given for prohibiting the use of intermediaries for senior appointments in the public sector. The solution to this perceived problem is different for the private sector: requiring the client business to operate PAYE and pay NICs, rather than banning the use of intermediaries for senior appointments.
It is unclear why any change is thought to be necessary for the private sector, other than possibly to level the field in recruiting senior staff. There is no evidence of widespread non-compliance by executives in the private sector, and no suggestion that the current shareholder and public concern over executive remuneration is directed at the use of personal service companies to engage senior executives.
The consultation raises other issues, not all of which are mentioned expressly. For example, there is little discussion as to which payments would be subject to PAYE/NICs and what the other tax consequences would be. Presumably, fees paid to recruitment consultants would not attract PAYE/NICs, but would the proposal apply to finder's fees (for example, if paid to a company in which the executive has an interest)? The consultation is silent on which "engaging organisations" the proposal will apply to. Even if it is to apply to payments by partnerships and LLPs, presumably this will not call into question HMRC's long-standing practice of accepting that all members of an LLP are taxed as self-employed.
Andrew Roycroft is a senior associate in the tax department at Norton Rose LLP.
The consultation is available at: http://customs.hmrc.gov.uk/channelsPortalWebApp/channelsPortalWebApp.portal?_nfpb=true&_pageLabel=pageExcise_RatesCodesTools&PropertyType=document&id=HMCE_PROD1_032074. Comments are invited by 16 August 2012.
The main issue raised by the joint HM Revenue & Customs/Treasury consultation on the taxation of controlling persons (the consultation) is: how widely should the net be drawn; in other words, how is "controlling persons" to be defined? The current proposal is to apply the new regime to anyone 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.
Significantly, the consultation does not take the option of proposing that only directors should be on payroll. This might be explained by the fact that the proposals are not expressly limited to companies, but it is more likely that others below director level in an organisation might have sufficient managerial control (for example, over employees or budgets) to be within this regime.
Arguably, non-executives would not satisfy this definition, particularly given the supervisory role which they perform. The consultation asks for views on the width of this definition, and suggests that the government is open to either narrowing the definition or extending it so that a larger group is caught. Whichever definition is used, it should be clear, so that all parties know what their tax obligations are.