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During 2012 the national press published a number of stories regarding the use of personal service companies by well-known individuals in the BBC and more widely by senior employees in the public sector. These stories formed one part of the general increase in media and public attention in recent times on different forms of perceived and actual tax avoidance.
With these stories forming the backdrop, the Government released a consultation paper on 'The Taxation of Controlling Persons'. The paper sought views on the introduction of new legislation that would require senior individuals (including office holders, such as non-executive directors (NEDs)) engaged by organisations to have income tax and National Insurance deducted at source on their payments, irrespective of whether the payment was made to the individuals' personal service companies.
In December 2012, the Government published a response to the consultation paper which confirmed that new legislation would not be enacted but that the scope of "IR35" would be extended for income tax purposes to cover office holders (office holders are already covered by the existing National Insurance contributions (NICs) IR35 legislation). "IR35" is the commonly-used name for the anti-avoidance legislation targeted at intermediary arrangements, typically involving personal service companies, that has been in place since April 2000.
This article will provide an overview of how this extension to IR35 may impact on arrangements that NEDs have in place with engaging companies, briefly reviewing the taxation of NEDs' fees more generally.
The taxation of NEDs is an area that is confused in practice, as a respondent quoted in the December 2012 response paper acknowledged:
What should be clear and demonstrated is that both executive and non-executive directors who are personally appointed to the board of a company are office holders and therefore must be subjected to PAYE/NICs, regardless of the contractual arrangements. We believe that most companies, and particularly large listed companies, would comply with clear HMRC guidance.
As the respondent asserted, the law in relation to fees paid for the duties carried out by individuals appointed as NEDs is clear, and remains unchanged without requiring consideration of IR35: any personally appointed director (whether executive or non-executive) is, in effect, deemed to be an employee of the engaging company for the purposes of the income tax and NICs legislation. As a result, and irrespective of the contractual arrangements in place (eg the contract is with the NED's personal service company, and the company receives the director's fees accordingly), PAYE and class 1 NICs should be deducted and accounted for at source by the engaging company.
In certain specific circumstances, such as where a director's fees are passed on by the director to a professional partnership of which the director is a member, or passed on to a company with a right to appoint the director or over which the director has no control, by concession and regulation HMRC allow PAYE and NICs not to be operated.
Furthermore, the general obligation to deduct PAYE and account for class 1 NICs applies in respect of fees paid for the duties carried out in connection with the office of director. It may not apply where the fees are paid for additional (and genuine) consultancy services that may be carried out by the NED on a self-employed basis. In such circumstances, provided the consultancy relationship is properly documented, fees may be paid without deduction for PAYE or NICs to the personal services company.
The changes to IR35 contained in the Finance Bill 2013 (on the assumption they will not be altered prior to royal assent) impact directly on personal service companies that receive NED fees without deduction for PAYE or NICs and where either (i) the NEDs are individuals appointed as directors of the engaging company or (ii) their personal service companies are appointed as corporate directors of the engaging company but the NEDs personally perform the non-executive director role. These changes apply because a NED holds the office of non-executive director and is therefore an "office holder" for the purposes of the legislation. The changes will also bring IR35 for income tax purposes into line with the equivalent NICs legislation, which already applies to office holders.
If IR35 applies for income tax and NICs, the personal service company is obliged, generally at the end of the relevant tax year, to deduct PAYE and account for class 1 NICs on all gross payments received by the company in respect of the NED's duties.
Prior to these changes, which will have effect from 6 April 2013, for IR35 to apply for income tax purposes it was necessary for there to be, in reality, an employment relationship between the NED and the engaging company (ignoring the personal service company). Given the nature of the non-executive director role, this test was usually not satisfied by NEDs and therefore IR35 was not relevant.
Unless the HMRC concession referred to above applies, the changes to IR35 mean that PAYE and NICs will generally apply to NED fees. Whether the obligation to operate PAYE and NICs falls on the engaging company or the personal service company will depend on the facts in each case.
Both engaging companies that continue to pay NED fees gross and NEDs with personal service companies receiving fees paid gross should review their arrangements to ensure they are compliant with the new, and existing, legislation.
Following the increased focus and resources devoted to policing IR35 introduced in April 2012 and the Government's assertion in the December 2012 response paper that it intends to keep this area under review, it is likely that HMRC will be scrutinising these arrangements more than in the past.
For more information please contact Robert Birchall, Associate
T: +44 (0)20 7427 6659