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I am writing in relation to the P35s that employers will be required to complete and submit to HMRC in the next couple of months and, in particular, the question concerning service companies.
Background
As you may be aware, the First-tier Tribunal (Tax Chamber) has had to deal with a considerable number of cases in the past year or so in relation to employers who appear not to have complied with their obligations under Regulation 73 of the Income Tax (Pay As You Earn) Regulations SI 2003 No 2682 (‘the PAYE Regulations’).
That provision requires employers to provide an annual return (P35) of payments made to employees by 19 May following the end of the tax year to which the return relates.
The cases tend to relate to penalties which have been charged by virtue of the provisions of TMA 1970, s 98A and which are prima facie payable if a return is not made as required by Reg 73.
I say ‘prima facie’ because TMA 1970, s 118(2) excuses any such failure whilst a person has a ‘reasonable excuse’ for not doing what is otherwise required by the statute.
As you may also be aware, a direction has been issued under Reg 205(2) of the PAYE Regulations requiring virtually all employers to make P35 returns online.
The standard form P35
Over the past few years, the P35 return has contained a question ‘Are you a service company?’ The guidance notes in booklet CWG2 and the online help screen attempt to explain what is meant by the term ‘service company’.
They state that an employer which is not even a company can, for the purposes of this question, be a service company.
The notes also purport to explain that an employer’s status as a service company depends on whether or not an individual provides service to the employer’s clients and whether or not over half of the employer’s turnover derives from personal services provided by partners or shareholders of the employer.
I do not propose to discuss this guidance further, other than to say that HMRC guidance often changes over time and is therefore of limited value for such purposes. More importantly, the definition is entirely arbitrary, more so because it does not accord with any statutory provision. Indeed, my main concern is the P35’s incompatibility with the statutory provisions that underlie it.
Regulation 73 is set out in full below. It should therefore be quite clear that the PAYE Regulations are very prescriptive as to what information needs to be included on an employer’s annual return and, so far as the legislation is silent, what information is totally unnecessary.
Consequently, it must be the case that no employer need answer the question about service companies and any imposition on an employer to answer that question must similarly be ultra vires.
My understanding, however, is that the electronic P35 cannot be submitted online unless the employer answers the question either ‘Yes’ or ‘No’.
Here is a what happens if electronic submission is attempted while the question is left unanswered.
However, given the lack of statutory backing for the question it must be unreasonable (if not otherwise unlawful) for the software to impose this additional requirement on employers.
Furthermore, I suspect that most employers are keen to answer questions on tax returns honestly and accurately.
Given that the only definition of ‘service company’ is given in non-statutory guidance and that the published definition gives rise to anomalies, it is fully understandable that many employers would feel uncomfortable about answering it in such unequivocal terms (i.e. yes or no).
However, given the lack of statutory authority for the question, it is quite clear that they should not need to.
Therefore, it is my view that employers would currently have a reasonable excuse for not submitting their P35s online as the software currently requires them to answer a question that they are under no statutory obligation to address.
Indeed, it is conceivable that, as things presently stand, no employer need send in a P35.
Of course, this would lead to a rather unsatisfactory state of affairs as I assume that HMRC would prefer to receive P35s than not.
May I therefore invite HMRC to adopt one of the following approaches to ensure that the PAYE system does not suffer further meltdown in the coming weeks.
Either:
- revise the software so that employers can simply ignore the service company question on the P35 yet still be able to file their annual returns online;
- announce that HMRC will simply ignore any answers given to the service company question and not use any response as ‘evidence’ against the employer or any of its employees;
- allow employers to send in P35s in paper form with the service company question left unanswered; or
- revise the legislation so that it matches the obligations imposed in reality and to ensure that there is a clear statutory definition of the currently rather mercurial concept of a service company.
Given the widespread interest in the tax profession concerning this issue, I have sent a copy of this letter to the editor of Taxation magazine. I am sure that he would be interested in hearing from HMRC in respect of this matter and learning how HMRC propose to proceed.
Keith M Gordon
I refer to the open letter written by Keith Gordon to HMRC on this issue which was posted on Taxation on 28 March, regarding the question on the P35 as to whether the employer is a service company. I hope that HMRC will respond to the letter before 19 May but am not hopeful of this. In the meantime I am interested in what stance others are taking when filing the P35.
Keith explained that there is no statutory requirement to answer the service company question, but that practically the question has to be answered in order to submit the P35 electronically. Do readers think it justifiable to take the stance that as there is no legal requirement to answer the question at all, the employer could answer "no" on the basis that he has to choose an answer to submit the form (even if the employer is a service company, based on the HMRC's guidance of what constitutes a service co)?
And what are the implications if the P35 is submitted with "no" as the answer and HMRC subsequently take the view that the answer should have been "yes"? HMRC can charge a penalty for an inaccurate P35 but from my understanding it is tax geared, so if the loss of tax is nil the penalty for inaccuracy should be nil. If IR35 does not apply, but it is found that an employer has incorrectly answered the question as to whether they are a service company, there would be no change to the tax position by correcting this answer (unless of course it was also found that IR35 does apply). Are there any other penalties which could be charged?
I would be grateful to hear the opinions of anyone else dealing with this issue, and what stance they are taking.