The ‘service company’ question – P35 and tax returns
HMRC requires employers and individuals to answer questions in relation to service companies when they complete the following annual tax returns, but they have different meanings:
Form SA100, the personal tax return - ‘service companies’ are restricted to companies.If you provide your services through a service company HMRC requires you to enter the total of the dividends grossed up by 10/9 and gross salary you withdrew from your company in the tax year into a box in the main section of the Self-Assessment return. This is in addition to completing the dividend and employment sections of the return. There is no requirement to report benefits and expenses in this section (you of course complete the employment section for those).
What is a service company for the purposes of the SA100 return? Well, HMRC describes a service company as “one which provides your personal services to third parties”.
HMRC defines the provision of your services as:
- - you performed services (intellectual, manual or a mixture of both) for a client (or clients), and
- - the services were provided under a contract between the client(s) and a company of which you were, at any time during the tax year, a shareholder, 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 services performed by the shareholders personally.
Form P35, the employer end of year return - ‘service companies’ include companies, partnerships (but not sole traders) and limited liability partnerships
The employer has to decide whether their business provides services rather than goods to clients. If so, whether more than 50% of its income is derived from services provided in person by the partners or shareholders. The answer to this question depends on the fee earning capabilities of partners and shareholders. A professional services contractor with a one man company will answer “Yes” to this question.
The second part of the question asks if income has been treated as deemed employment income and tax and NIC deducted under the IR35 rules. These will not apply to the income of most Careful consideration is needed in respect of the income of a professional services contractor. Employers who answer ‘Yes’ to the first part of the question will not necessarily answer ‘Yes’ to the second part as they may not be within IR35 or an MSC. Forms P35 will show a ‘Yes’/’No’ combination.
Why do these questions matter?
These questions matter, because if they are completed incorrectly and the outcome is a loss of tax, tax penalties can potentially apply to the employer.