The service company question: P35s and SA tax returns
- Last Updated: 28 March 2014
Do I have to answer the service company question found on the SA100 and P35 tax returns?
Why does it matter?
HMRC makes employers and individuals answer questions about service companies when they complete the following annual tax returns:
- SA100, the personal tax return.
- P35, the employer end of year return.
What are ‘service companies’?
The term is not defined in tax law.
- For SA100 returns ‘service companies’ are restricted to only to companies.
- For form P35, ‘service companies’ include companies, partnerships (but not sole traders) and limited liability partnerships.
Service companies: Self-Assessment
If you provide your services through a service company HMRC requires you to enter the total of the dividends grossed up by 10/9 and gross salary you withdrew from your company in the tax year into a box in the main section of the Self-Assessment return. This is in addition to completing the dividend and employment sections of the return.
There is no requirement to report benefits and expenses in this section (you of course complete the employment section for those).
What is a service company for the purposes of the SA100 return?
HMRC describes a service company as “one which provides your personal services to third parties”.
HMRC defines the provision of your services as:
- you performed services (intellectual, manual or a mixture of both) for a client (or clients), and
- the services were provided under a contract between the client(s) and a company of which you were, at any time during the tax year, a shareholder, 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 services performed by the shareholders personally.
The employer has to decide whether their business provides services rather than goods to clients. If so, whether more than 50% of its income is derived from services provided in person by the partners or shareholders.
The answer to to this question depends on the fee earning capabilities of partners and shareholders.
- Most smaller accountancy and legal practices (which employ few members of fee earning staff) will be service companies, and should answer “Yes” to the first question.
- A professional services contractor with a one man company will answer “Yes” to this question.
The second part of the question asks if income has been treated as deemed employment income and tax and NIC deducted under the IR35 rules (or under the MSC rules). These will not apply to the income of most accountants and lawyers, but some consideration may be needed in respect of the income of a professional services contractor.
Employers who answer ‘Yes’ to the first part of the question will not necessarily answer ‘Yes’ to the second part as they may not be within IR35 or an MSC. Forms P35 will show a ‘Yes’/’No’ combination.
Why do these questions matter?
These questions matter, because if they are completed incorrectly and the outcome is a loss of tax, tax penalties can potentially apply to the employer or individual who signed the return.
If you tick the box on the P35 to say that IR35 does not apply to your company's income, and it transpires that it actually did, and you did not take proper guidance to establish this at the time, then you potentially face a penalty for negligence.
Is it legal for HMRC to ask these questions
Barrister Keith Gordon has led the debate over the last few years as to whether HMRC has the right to ask the service company question on the SA100 return, and whether a return is complete if you refuse to answer it. Keith has, according to his blog, been refusing to answer it.
HMRC for their part, are presumably just gathering data and presumably feel that requiring taxpayers to answer the question ensures that the mind in focused. Alternatively, many taxpayers would rather not have HMRC nosing into their affairs as the cost of an IR35 enquiry is prohibitive.
It was announced in the 2011 Budget that IR35 was not going to be abolished or changed and that HMRC would focus on ensuring that it published better guidance.
Complete all questions in tax returns with care, whilst there are potentially penalties under the error in a return and documents provisions, there can only be a penalty if a mistake results in a loss of tax.
- A service company owner is already required to declare his dividend income and employment income in other sections of the return: no penalty can apply if the service company question is answered incorrectly if the income is declared correctly elsewhere.
- If it transpires that IR35 applies, but the taxpayer did not realise and the taxpayer has failed to answer the question, he will have also self-assessed his income elswhere on the return incorrectly, or not at all. A penalty may apply, but again this will not be by virtue of his answer to the service company question, it will be in relation to the other entries on the return.
- If the question is not answered, then it is unclear whether the return is actually complete because if all income and gains are declared and then surely the taxpayer has done that which is required by the taxes acts - this is Keith's point.
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