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P35 'service company' question for limited company contractors

Published on Apr 16, 2009 |

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Limited company contractors are required to submit their P35 (employer annual return) forms to HMRC by 19th May.

The P35 details the tax and national insurance contributions paid by each company employee during the 2008-9 tax year.

On this year's P35 return, section 6 of Part 3 has the potential to cause confusion (as it did last year).

Are you a service company?

There are 2 questions in section 6 which need to be answered:

1) Are you a service company?

2) If "yes", have you operated the Intermediaries legislation (sometimes known as IR35) or the Managed Service Companies legislation?

How should you answer these questions?

According to the official guidance (PDF), 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.

HMRC clarifies things by stating that, in this context, the term "service company" includes a limited company, a limited liability partnership (LLP), or partnership.

Clearly, most limited company contractors will answer "yes" to the first question based on the HMRC guidance.

Answering the second question is more straightforward (are you caught by IR35, or the MSC legislation).

Most commentators are also agreed in that if you answer "no" to question 1, you should also answer "no" to question 2.

What are HMRC's motives?

If you answer "yes" to question 1 (are you a service company?), and "no" to question 2 (are you caught by IR35, or are you an MSC), some industry experts think this may trigger a tax enquiry.

Accountants Reilly McMordie state:

"We believe HMRC is using this to try to identify companies that may be subject to IR35 or the MSC rules but are not operating them."

Rebecca Bennyworth, editor at AccountingWeb, says:

"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."

You can read Rebecca's analysis of the situation here.

Also try the PCG's article on filling in this year's P35 here.

Taxation Web has also published an interesting letter from a tax barrister who has taken exception to the 'service company' question on the 2009/10 self assessment return.