Inland Revenue Warns Composite Service Companies Over IR35

by Jason Gorringe, Tax-News.com, London

16 August 2002

In its Tax Bulletin Issue 60, published on Wednesday, the UK Inland Revenue issued a further warning to contractors renumerated for their work via service companies.

IR35 legislation states that where an individual ("the worker") personally performs services for the purposes of a business carried on by another person ("the client"); but does so via a service company rather than directly; and works for the client in such a way that they would be regarded as an employee of the client, had they worked for them directly rather than via the service company, the service company must deduct and account for tax under PAYE and Class 1 National Insurance contributions in respect of that worker on (broadly) all of the money the service company receives from the client in respect of work done for the client.

The Inland Revenue Bulletin points out that this applies equally whether the service company employs one or two clients (i.e.is a personal service company), or whether, as a composite service company, it employs many contractors.

Composite service companies can be found in a variety of sectors, and usually employ a number of workers, which they then supply to clients. Employees of this type of service company are usually paid a small salary, and in addition are shareholders in the composite company, which allows them to receive the majority of their income as dividends, a path which offers significant tax benefits.

However, the Inland Revenue has stressed that the size and structure of the composite service company has no effect on the tax status of its 'employees', and that when the conditions detailed above apply and 'the worker either holds 5% of the shares in the service company or receives payments that could reasonably be taken to represent renumeration for services provided by the worker to the client', the provisions of IR35 will still apply.

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