Form P35 Question 6 - better now? by Rebecca Benneyworth

After the drama last year with the new question six on form P35 have we faired any better this year? I take a detailed look at this year's guidance. Last year HMRC issued supplementary guidance part way through the P35 filing season. Have they got it "right first time" this time?

Employer Helpbook E10(2009) provides the current guidance on how to complete question six on form P35. Once again, the question is in two parts, and if the answer to part 1 is “No”, then part 2 should be answered in the negative too.

Part 1

Are you a service company?

The guidance on page 18 of Helpbook E10 provides the following help in deciding how to answer this question. It states :

“The first question should be answered yes if:

• an individual performed services (intellectual, manual or a mixture of the two) for a client or clients, and
• the services were provided under a contract between the client and the company of which, at any time during the tax year, the individual performing the services was a shareholder or partner, 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 the services performed by the shareholders or partners personally.”

The guidance further adds that for the purposes of this question, the term “service company” includes a limited company, a limited liability partnership or a partnership.

So let us first consider this guidance in the context of some examples :

1. A jobbing builder operating through a limited company

The services provided by the director of the company are provided to clients under a contract (although possibly a verbal one). Points one and two satisfied. If the business has had plenty of private client work this year, then it is likely that the cost of materials is in excess of the charges for labour, so point three is negative, and he answers “No” to both parts of Question 6. However, times have been difficult and he has accepted subcontract work from a large contractor, erecting wind turbines. These have been undertaken through the company, and have been his only source of work in the last six months. Because the company’s income is so low, this forms more than half of the turnover for the year. At this point I am tempted to answer part 1 in the affirmative. If only I understood what was meant by “personally” here.

2. A firm of accountants – two partners, and no staff

Clearly, once again we have a potential “service company” for Question 6, as this time we have a partnership. The responses to points one and two are an unequivocal “yes”. On to point three. Once again are these services performed “personally” by the partners? There is no doubt that if they are, the answer is yes and we have to go on and consider Question 2. But what if the firm employed someone? Although there are no employees at the moment, does this mean that the firm could use the services of any available and suitably qualified individual to perform the services for the client? I think they could, and here I contest the use of “personally”. Neither of the partners performs the services in his personal capacity, and the services could easily be provided by someone else within the firm. So I’m thinking “no” to point three, making part 1 a “no” again.

As I have shown, although the guidance is much improved over last year, the entire question turns on the interpretation of the word “personally” in part 1 of the question. If I am right, then the question should not be an issue for many businesses currently concerned about this issue. Part 1 being negative, part 2 follows as a negative – job done.

Part 2

If 'Yes', have you operated the Intermediaries legislation (sometimes known as IR35) or the Managed Service Companies legislation?

The guidance states : “The second question should only be answered yes if income has been treated as deemed employment income and PAYE/NICs deducted in accordance with the Managed Service Company or Intermediaries legislation (IR35).” This is amplified by stating “If you have deducted PAYE and NIC’s on deemed employment payments…..tick the second box ‘Yes’.”

However, there is more help for those affected by IR35 (but not the MSC legislation). The following additional guidance is given :

• Where an engagement is within the rules but the deemed payment is nil because sufficient amounts of employment income have been paid, you should also tick the second box ‘Yes’.
• If you tick the second box ‘Yes’ but the amount of the deemed employment payment is provisional, confirm this on a separate sheet and send it with your P35.

Possible scenarios – after part 1 is answered in the affirmative :

• You have calculated the PAYE and NIC on the deemed employment payment in full, and reported it on P35 – part 2 is Yes. (Only this option applies to companies within the MSC legislation)
• You have estimated PAYE and NIC on the deemed employment payment and reported the estimate on P35 – part 2 is Yes, and you need to indicate that the amount is provisional. Finalise by 31 January 2010 at the latest. Interest runs from 19 April on the unpaid amount of PAYE and NIC at current rate of 2.5%
• You have not calculated a deemed employment payment because all of the affected income has been paid out as employment income, so the deemed amount would be nil – part 2 is Yes.
• You have not calculated a deemed employment payment because although the answer to Part 1 was Yes, you believe that the contract terms and engagement terms and conditions put you outside IR35 and MSC legislation – part 2 is No.

I suggest that the likely outcome of a “Yes” and “No” response to Parts 1 and 2 respectively is a compliance check to see whether the contract and engagement terms stand up to scrutiny.

Well I do think that the new guidance is clearer – much better than last year. But I would still like something on the use of the word “personally”. I think I am right – but the question is does HMRC agree?