Nichola Ross Martin weighs up practicality with morality when it comes to managing some kinds of investigation risk, “In a throw-away society who cares about goodwill and reputation?”
One of the more sinister aspects of HMRC’s latest service company questions which feature on the 2008 PAYE end-of-year return form P35 and SA tax return is that the data collected on you and your company can be stored and analysed. Whether the data collected this year will be any use to anyone is a moot point, whether anyone will remember this when reviewing it again in a couple of years is another.
The blockbuster tax case of Arctic Systems (Jones v Garnett) left the Treasury with a gigantic chip on its shoulder, and its attempts at introducing legislation to combat what it terms "income shifting" between spouses have been postponed. Note, postponed which means according to small business expert Simon Sweetman, that ministers are planning to introduce something far sharper in the future.
Tax pitfalls for owner managed companies
Over the past few years we have had a few good old elephant traps and threats of ones:
Legislation, like that postponed for shifting of earned income, is categorised as “anti-avoidance” by government. Its hallmarks are that it is:
The last few years have been very unsettling for limited companies and their advisors. How should one proceed this year?
Broadly drafted legislation
There is not too much that one can do if the legislation that hits the statute books happens to be broadly drafted; it’s far too late by then. The successor to the income shifting proposals may be slightly better targeted than last December’s version but until that comes in, companies and their owners will just have to wait and see. One man (or woman) personal service companies are high on the government’s hit list, and no denying that IT consultants are tops (Mr Jones, was an IT consultant, of course), however, business comes in all shapes and forms. If you run a small limited company which does not employ anyone outside the family you should be concerned about your tax future.
Backdating of provisions
When HMRC started applying the settlement provisions of what was then s 660A ICTA 1988 to small business, it also assessed earlier years. Interestingly HMRC tried to do this to the Jones in Arctic Systems, but fell down on a technicality. Earlier years may only be reopened if:
The defence against discovery in an earlier year is that a self assessment was made in that year on the basis of practice that was prevailing at that time. What is prevailing practice is a matter of judgement, it is the practice adopted by taxpayers, agents and HMRC. This rule prevents HMRC changing its mind at the drop of a hat about how it interprets tax legislation, however, this did not seem to stop its efforts with s 660A.
Measures to avoid the radar
Back in 2004 when the settlements fiasco was at its heights I was lecturing on the subject and so met numerous firms of accountants who were basically extremely worried about their clients. Of these several firms were systematically advising businesses that might be affected to close down and restart (one accountant claimed that he had done this for his entire practice – how’s that for opportunistic?) This is not so much staying below the radar, but ensuring that you are not in it. Drastic measures for drastic times, so I thought, but then the Managed Service Company (MSC) legislation was introduced there was a rush to incorporate companies. Individuals again changed their trading vehicle to accommodate the new legislation. Somewhere though the infection has spread, I now note that all sorts of businesses are phoenixing (closing down and restarting) in the normal course of business. From IT consultants to builders to beauty parlours, the rot has set in. In a throw-away society who cares about goodwill and reputation? In the new millennium we have throw-away businesses too.
Phoenixing
You are not breaking any laws if you cease trading as one business and start again with another name the next day. What you must not do is phoenix using limited liability companies or partnerships in an attempt to avoid your creditors, who might include you and me, as well as HMRC. That is quite simply, fraud. With self assessment this poses some interesting problems, what advice to you give to someone who is boarderline on IR35 and wants to hedge their bets for the future? Surely, it is worth mentioning that a new company to coincide with a new contract might be prudent? What about in a situation where there is fundamental uncertainty about future tax legislation? I am finding that many advisors regard this as a sensible approach to managing investigation risk.
Example: The Local Builder
I met a builder the other day who sets up a new company every few years. I asked, “Why” and I was told that it was as “advised by his accountant”. I am not sure that I would be too happy being a past customer (or future one for that matter) of this character. It makes you wonder if he has something to hide, is it a matter of liability for past unsafe works, or is the accountant worried about CIS/income shifting/future legislation? Changing companies seems to make no difference to the builder, he is inundated with work. Clearly his accountant has no moral qualms about this.
Has HMRC got the resources to chase up all those little building companies too?
Reinstating struck off companies
If you apply to have a company struck off without a formal liquidation, it may be reinstated up to 20 years later (only 2 if you do it by formal liquidation). Practically, it is costly for anyone to do this and HMRC will only try to do so, if they make a discovery at a later date. This may be very difficult to do.
Smoke screens: Measures to stay below the radar Insurance: Hedging your bets Conclusion: Not worrying about the radar? Nichola Ross Martin is a director of a virtual tax advisory and training service for accountants and their clients. She can be contacted by email. [1]
The old favourite for advisors is to tell clients that they should avoiding paying out all company profits as dividends. The idea being that you minimise investigation risk by creating a smoke screen which involves paying decent sized salaries – i.e. slightly higher than the annual personal allowance (and accounting for PAYE and NI) and then the balance of any profits are distributed as dividends. The radar picks up an owner managed company, but then apparently thinks “Good company, can’t be within IR35, settlements, income shifting, s 447 ITEPA, or whatever else is concocted next…” I wondered if HMRC would really fall for this, and whether some advisors have just been costing their clients more than was necessary in tax and NI along the way. Judging by on the new SA tax return about service companies it seems that in the future HMRC won't bother with analysis of your accounts. It can just ask a couple of direct and searching questions on your return instead.
You can of course insure against tax investigations but, insurance has its limitations, not only in the amount of cover provided, but also that most insurers will not cover a full tax inquiry. For business owners to be in a situation where tax legislation is potentially so ambiguous that we have no other choice than to pay insurers to protect us is a desperate state of affairs. If you have not got your own insurance, then a trade association may help; Geoff Jones was supported by the Professional Contractors' Group. The best thing about a trade association is that there is generally safety in numbers, and if all else fails you will have a shoulder to cry on!
Providing that legislation is not backdated, and providing you understand the current legislation then it would quite nice to be in the position of being able to self assess ones own company and personal tax without looking over your shoulder. This is surely the "stability" that the chancellor alluded to in his recent budget? However, when it takes a tax tribunal to determine your employment status to see if IR35 applies, or the House of Lords to determine whether you have a tax liability of not, then you have a very good reason to try and manage your tax investigation risk in a drastic way.
Links:
[1] mailto:nicki@rossmartin.co.uk