IR35 :Director's liability

Regulation 72(5) Conditions A & B

Introduction

By each 19th May, PAYE registered persons or companies are obliged to file a P35 return with HMRC. Contractors and Freelancers trading inside IR35 have alsoto declare the PAYE deducted on the deemed payment.

As both a Director and/or an employee of a Limited Company many Contractors and Freelancers do not realise that they can be personally liable to repay hundreds of thousands of pounds in PAYE if HMRC apply a Direction under Regulation & 72(5) Condition A or B.ed.

What happens if a company has declared the wrong amounts of PAYE?

If HMRC find that wrong amounts of Tax and NICs have been declared (or not), they have two redressess ( known as Condition A and B ), two entities to address them to (the company and/or its directors) and virtually no time limits in which to apply them.

Direction under Regulation 72(5) Condition A Was the under deduction an honest failure?

It is the employer who carries the prime liability to deduct PAYE. Under Direction 72(5) Condition A, HMRC possess the power to settle or make liable any underpaid or non-declared PAYE on the employee or director if they deem that the error or failure was an honest error on the employer’s behalf.

To do this, HMRC must first satisfy themselves that the employer took “reasonable care to comply with the PAYE regulations”, and that “the failure to deduct the correct amount of tax was due to an error made in good faith”

Contractors and Freelancers who operate their business through a single director owned limited company are in effect both employer and employee with regards to their limited company.

If the company became the subject of an IR35 investigation and as a result it was later established that the Limited Company had been operating in a manner putting them inside IR35, but had declared on P35 that it was operating outside IR35, the Limited Company would then owe HMRC a potentially large amount of PAYE.

HMRC could then seek a Direction under 72(5) Condition A to hold either the employee or the director of the Limited Company liable for this extra PAYE if they have satisfied themselves that the employer had took reasonable care to comply with PAYE regulations.

By virtue of Regulation 72(7) and (8) interest on top of the amount owed will apply and possibly penalties if HMRC assess that either the employer or employee didn’t take “reasonable care and acted in good faith when making the error”.

Contractors and Freelancers need to be aware then, that in cases of an IR35 dispute , HMRC could hold the worker/director/employee personally liable for the unpaid PAYE where the dispute is lost, even in cases where the employee/director did all they could to satisfy themselves that they were outside IR35.

Umbrella Company employees may well need to consider carefully their expense claims as if they have claimed expenses in error, but HMRC are satisfied that the employer has done everything in their power to operate PAYE correctly, the employee could be liable under a Regulation 72(5) Direction.

Was the under deduction a dishonest or wilful failure? – Regulation 72(5) Condition B.

Under Regulation 72(5) condition B HMRC can seek to obtain settlement of the debt from the director of the company where:

“An employee or director received payments knowing that the employer had wilfully (that is deliberately) failed to deduct the correct amount of PAYE from their earnings, and
the prospects of recovery from the employee or director are reasonably good

The regulations are used most frequently against directors in small private limited companies where they are in effect acting in two capacities:

as the employer paying themselves employment income and
as an employee

There must be firm evidence that the director at the time of the relevant payment had some stake in, or control of, the business finances of the company or was in a position to exercise such control”.

So in a case where a Contractor and Freelancer deliberatly ignores IR35 regulations and does not declare a deemed payment on a P35 then HMRC may seek a Direction under Regulation 72 (5) Condition B and hold the director of the Limited Company personally liable for the PAYE.

Company Closure

If an application for a striking off order has been made to close the company down, Companies House will write and advise the Inland Revenue to ensure all debts are paid before the company is removed from the register.

HMRC can object to a company being closed should they wish. They will do so if returns are outstanding or they wish to open an enquiry.

If HMRC choose to apply Regulation 72(5) Condition A and B , then regardless of whether the company is struck off or not; HMRC can claim settlement of the debt from the employee or director.

Conclusion

Contractors and Freelancers can be held personally liable for the PAYE debts in relation to their personal income from either a Limited Company or an Umbrella Company. There is no time limit for HMRC to use these powers, and it makes no difference if a company is closed down.

This article is heavily dependant on one by Phil Richards of BFCA which can be accessed here http://bit.ly/esjeb