Service companies - a question too far?

For those of you who have yet to complete your self assessment tax return for the year to April 2008, there is one question which was not very clear the first draft of the form. After discussion, HMRC have now issued some new guidance which explains when the box headed "service companies" needs to be filled in and what number needs to go in there.

A little background - the Government does not like a lot of one man companies since it sees them as a device for reducing tax bills from the high levels paid by sole traders to the more modest levels paid by small companies. Of course the difference is not in the rate of tax but the fact that sole traders have to pay national insurance as well as income tax.

The Government want to know how big the problem is and therefore, as well as asking questions directly related to tax liabilities, they have also added a further question on the form to find out how many people are involved in personal companies and how much they are getting from them.

Unfortunately the question on the tax return form is not very well targeted and will need to be filled in not only by people who run their own small companies but also by share holder / employees of a lot of services companies (Accountants, Lawyers etc).

What will the Government do with the information? Perhaps there will be so much of it that they cannot cope with it. They already have "IR35" on the statue book which will allow them to collect PAYE and NIC from companies instead of the corporation tax which has been paid so far. Of course this is subject to them being able to prove that IR35 does apply to the company concerned.

Also we are awaiting proposals for "income shifting" rules which will come in from 6 April 2009. These are rules to make sure that, in husband and wife companies, any dividends are taxed on the person with a higher rate of tax rather than on the person legally entitled to the dividend under company law.

So be warned - HMRC assure us that they can gather this sort of information on the tax return even though it does not directly relate to the current year’s tax liability - and they may well have a few follow questions to see whether they could ask for a little bit more tax in future.

What are the rules -

1. You are the shareholder in a company

2. That company provides your professional services

3. More than half of the company’s turnover is derived from providing the services of shareholder / employees

This means the rules cannot apply to wholesale and retail operations since the turnover is derived from the sale of goods and not services. It also means that employees who work behind the scenes rather than providing services direct to the company’s customers do not need to disclose anything (since they are not providing any services themselves).

For some more details on what needs to be disclosed look at the Inland Revenue press release at www.hmrc.gov.uk/sa/service-companies-question.htm