Revenue warns composite companies on NIC and travel

Early in December I wrote that the Inland Revenue were about to issue a tax bulletin that would include guidance aimed mainly at contractors working through composite and umbrella companies.

This guidance has just been issued in tax bulletin 74 (see copy attached). It focuses on two particular problems that the Revenue has identified in its compliance reviews of composite companies and managed services companies.

These are:

• the application of the NIC deemed employed earners legislation to teachers and others, and

• the application of the temporary workplace rules for travel and subsistence in situations where the worker may only have one contract while working through a composite or managed service company.

Teachers

In my previous article I highlighted the issue that stems from the fact that, in most situations in which teachers work, they are deemed by NIC legislation to be "employed earners" regardless of what their tax status may be. This means that even where their contractual terms enable them to operate as if they were self employed and outside IR35 for PAYE purposes, they are almost certainly going to be treated as if they were employees for NIC purposes.

Under the service company legislation, one of the tests for tax is whether the worker "would be regarded for income tax purposes as an employee of the client" if engaged directly. However, under the NIC legislation, the test is whether the worker would be regarded as employed in employed earner's employment by the client. As well as teachers the NIC legislation also has similar rules for cleaners and entertainers, who are also deemed to be employed earners for NICs.

In addition to these, office holders, who are gainfully employed in the UK with general earnings are included within the meaning of employed earner, in addition to those employed under a contract of service. Consequently non-executive directors without a contract of service fall within the intermediaries legislation for NICs, but not for tax.

It appears that some managers of composite companies and managed service companies were not aware of this aspect of the NIC legislation and had allowed teachers (frequently supply teachers) to operate as if they were outside IR35.

In addition to publishing the tax bulletin the Revenue has also written letters to most composite company managers clarifying the issue and they have also written to all the agencies that the Revenue believes handle teachers to point out that in most circumstances teachers cannot be treated as being outside IR35 for NIC purposes.

Liability

Teachers, who are working through a service company and who have been taking dividends on the basis that they were outside IR35, need to consult their advisers or the service company managers as soon as possible. The service company will almost certainly have a liability to employer's and employee's NIC under these deemed employment rules.

It is also quite probable that their eligibility to operate outside IR35 for tax purposes could be called into question. It is quite difficult to conceive of a contractual and working relationship for a mainstream teacher that is clearly outside the IR35 status tests. Only those who work from home or provide tutoring services at the student's home, or who have complete control of the manner in which they teach are likely to be able to demonstrate that they are working on a self employed basis. Certainly someone providing supply teaching services at a mainstream school is most unlikely to be operating on a self employed basis that passes the IR35 tests.

Clearly this is an issue that the Revenue are focussing on and they will be seeking to review many of the large composite and managed service company providers to establish the extent of the underpayment of NIC.

With regard to the NIC the liability is that of the service company. However, if there are NIC liabilities that the company cannot meet then the Revenue is able to pursue individual directors or managers - if it is established that the failure to pay the NIC stems from fraud or negligence on the part of the directors or managers. Given that many composite companies operate on the basis of paying out most of the company's profits monthly, composite companies rarely hold sufficient reserves to be able to meet more than a fraction of their potential liabilities and the Revenue will be looking elsewhere for payment.

The service company providers will need to review their structures to see whether they could be held liable for the NIC owed by the service companies they manage – whether as directors or shadow directors. However, those managers who value their reputation within a very competitive marketplace may seek to reach a settlement with the Revenue on behalf of their service companies, even where the liability is not theirs.

Travel and subsistence

The other issue that the Revenue has identified from recent compliance reviews is whether the worker can validly claim to be working at a temporary workplace if they only have the one contract while working for the service company. The current rules relating to claiming travel and subsistence costs stem from April 1998. Following changes introduced at that time workers can claim the costs of travelling to a "temporary workplace".

That rule is now contained in Sections 338 and 339 ITEPA 2003 and there is existing Revenue guidance on this issue in the form of their booklet 490. The basic proposition is that an employee may deduct expenses which are attributable to his or her necessary attendance at a place in the performance of their duties, unless the journey counts as ordinary commuting or private travel.

The tax bulletin summarises the basic rules relating to permanent and temporary workplaces and ordinary commuting. Section 339(3) defines a temporary workplace as a place that the employee attends to perform a task of limited duration, or for some other temporary purpose. This is the only definition of a "temporary workplace". If there is no identifiable task of limited duration, or other temporary purpose for the employee's visit then:

• the place cannot be a temporary workplace, as defined, and

• if the employee visits the place regularly (so that it is a permanent workplace) the expenses of the journey will not be deductible.

If there is an identifiable task of limited duration, or some other temporary purpose for the employee's visit, there are two further rules which may still prevent a place from being a temporary workplace. They are the "24 month rule" and the "fixed term appointment rule". Both are in Section 339(5). Most contractors are reasonably familiar with the 24 month rule.

The 'fixed term appointment' rule says that a place cannot be a temporary workplace if the employee's attendance is:

• in the course of a period of continuous work comprising all or almost all of the period for which the employee is likely to hold the employment, or

• if it is at a time when it is reasonable to assume that it will be in the course of such a period.

The bulletin points out that for workers who provide their services through the medium of a composite company or managed service company the operation of this rule depends very much on the nature of the employment contract between the worker and the company. The bulletin sets out two broad possibilities:

• The worker has a succession of discrete employment contracts with the company, each lasting only as long as the assignment on which the employee is engaged.

• The worker has an ongoing or "over-arching" contract of employment which covers all the employee's assignments with the company.

Which of those alternatives applies can only be determined by considering the terms of the individual contracts. The tax bulletin argues that if the worker has a succession of discrete employment contracts with the company, each one involving attendance at a single site and each lasting only as long as the assignment on which the employee is engaged, none of the places visited will be a temporary workplace. Each visit will last only as long as the discrete employment concerned so the fixed term appointment rule will apply.

Where there is an ongoing or "over-arching" contract of employment covering all the assignments that he or she undertakes for the company, it may well be that none of those assignments will last, nor be expected to last, for all or almost all of the period for which the employee holds the over-arching employment. In that case the fixed term appointment rule will not apply. If the employee spends less than 24 months at each site each one will be a temporary workplace – assuming of course that the basic "task of limited duration/other temporary purpose" test is met.

However, if the worker has a history of moving from one composite company or managed service company to another, undertaking just one assignment for each company, then the Revenue will try to argue that each new employment/assignment would be regarded as a permanent workplace unless and until it could be shown that, on a particular occasion, the employee would in fact be moving on to a second or subsequent assignment with the same employer.

In addition, if an individual expects - when they take up the employment with the composite - that the assignment on which s/he is working will be their only one because, for example, s/he is filling in time between permanent assignments, or s/he is returning to an overseas country, then the individual would not have a temporary place of work. Hence their travel and subsistence expenses will be fully taxable and subject to NICs.

This could be of particular significance for those composite companies that target contractors who come to the UK from overseas expecting to undertake just the one assignment before going on their travels or returning home. They will need to ascertain the intentions of the worker in order to have some grounds for assuming that the first contract is really a temporary workplace. This will be an issue not only for composite company managers but also umbrella companies where the worker is an employee rewarded entirely by salary and expenses paid under PAYE.

Once again workers and company managers need to consider how this clarification of the temporary travel rules could impact upon them and their policies.

Kevin Miller, MA FCA