The Revenue Contractors Project is now well underway with a large number of audit notification letters issuing to taxpayers in all Revenue Districts. Under this project the focus is on companies set up by individuals as a vehicle to provide contracting services. Revenue define these as companies “where the main source of income is a contract or contracts for service with a larger company or companies (directly or through intermediaries), the company in question does not appear to have a substantial business separate from these contracts, and in most cases the director(s) are the only employees of the company and pay tax through PAYE.” Experience suggests that this practice is particularly prevalent in certain industries e.g. the software sector.
Revenue are carrying out their review by way of a desk audit of the personal service company and its directors and are looking at a four year period in almost all cases. The main focus of Revenue appears to be on the veracity of expenses claims by directors and other deductions taken by the company from its taxable income.
The audit notification letters all appear to take a standard form and request a significant amount of detail in respect of the personal service company and its directors. One concern for practitioners and their client’s is the large amounts of information requested in a relatively short period of time. In addition to gathering the requested information the practitioner and client may require time to review the information to determine whether a voluntary disclosure is appropriate. Recognising this burden, Revenue has outlined the following concession:
“If the taxpayer decides not to make a disclosure, or that there is no disclosure to be made, we agree as a concession applying to this project only that, rather than sending all documentation to the District within 14 days, a letter from the taxpayer saying that there is nothing to disclose, and enclosing a brief reconciliation for the four years in question will be acceptable. A taxpayer should make their best efforts to comply with this requirement within the timeframe. Revenue will not rule out discussion on the contents where that would be helpful.
The reconciliation is required to reflect the fact that these cases have been selected because of the apparently high levels of tax-free deductions from gross income. The reconciliation should show, for each year, the major (5% or more) deductions from gross income to arrive at the salary paid to the contractor(s). A note explaining unusually high expenses should also be included. It may be that the nature of a business is such that expenses that would otherwise appear high are fully justified. We will then consider these reconciliations, and revert with more specific requirements to allow the audit to be conducted.”
The Revenue audit notification letter fails to detail the 60 day extension that can be availed of by taxpayers who wish to make a voluntary disclosure, however, Revenue have also later confirmed that Districts will allow the normal 60 day extension to facilitate the completion of a voluntary disclosure.
Travel and subsistence expenses
The main focus of the Contractors Project appears to be on expense claims by the directors of personal service companies, particularly travel, subsistence and similar type expenses. Revenue recently published Tax Briefing Issue 03 of 2013 outlining its view on these matters. In the Tax Briefing, Revenue summarise their previously published guidance on expense claims: Statement of Practice SP IT/02/2007 and Revenue Leaflets IT 51 and IT 54.
An area of particular focus for Revenue appears to be the payment of expenses for travel from the base of administration for the service company (typically the home of the director) to the place of work with the company that is engaging the service company. It most cases, the area subject to disagreement is the contention by the director in such cases that their normal place of work is the base of administration for the service company and that by travelling to the base of operation of the engaging company that they are incurring travelling expenses that may be paid to them tax free. Revenue have outlined their view in Tax Briefing Issue 03 of 2013 that it does not accept that the location at which the administration of the service company is carried out and its books kept constitutes a normal place of work of the director. The consequence of this is that any expenses that have been paid by a company for such travel would be regarded as a perquisite of the employment and subject to PAYE/USC.
A lack of focus on good record keeping is an unfortunate characteristic of some small businesses. Where adequate records and supporting documentation are not kept expenses may not be reimbursed free of tax to directors and in this regard the personal service company should have operated PAYE/USC on such payments. This is an area also subject to Revenue’s attention under the Contractors Project. Taxpayers are obliged to keep adequate records for a period of six years under the Taxes Consolidation Act 1997. With regard to mileage payments best practice is to retain the following records:
- the name and address of the director;
- the date of the journey;
- the reason for the journey;
- the kilometres involved;
- the starting point, destination and finishing point of the journey.
With regard to the reimbursement of actual expenses vouched by receipts, the company should retain such receipts, together with details of the travel and subsistence expenses incurred.
Close service company surcharge
If the personal service company is carrying on a profession, providing professional services or holding an office or employment the profits of the company may be subject to the close service company surcharge. Half of the undistributed profits of such a company are subject to a surcharge of 15%. If the directors of such companies are unaware of this surcharge and the profits of the company are large, the tax underpayment can be quite significant.
It is often not clear whether a company is carrying on a profession or providing professional services. Case law has found that profession involves an occupation requiring either intellectual skill, as in painting, sculpture or surgery or skill controlled by the intellectual ability of the operator. Revenue have outlined in Tax Briefing 48 the activities that in its view amount to a profession (note the list is not exhaustive).
Audit of the personal affairs of the director
While the details Revenue are requesting in respect of the personal tax affairs of the directors are not as detailed as that requested from the company, the level of information required is still quite onerous. It is clear that Revenue’s recent trawl of the tax affairs of landlords has yielded dividends and the same methodology appears to be now applied to directors who own rental properties. The focus seems to be on personal investment income that the director may have and how any income producing assets (e.g. rental properties) were acquired and financed. Copies of loan applications and mortgage statements may be sometimes requested.
Revenue have stated that they will treat under-declarations of tax arising in personal service companies as stemming from deliberate behaviour. The most significant aspect of this is the level of penalty that attaches to deliberate behaviour vis-à-vis careless behaviour. It is worrying from a macro perspective that Revenue are willing to treat all taxpayers the same, regardless of whether the default is deliberate or not; this is certainly not fair and equitable.
Practitioners are within their right to resist the imposition of penalties for deliberate behaviour where it is clear and arguable that the behaviour that gave rise to the tax default was not deliberate in nature. Deliberate behaviour is not defined for the purposes of the Tax Acts and therefore takes its normal meaning. Revenue regard deliberate behaviour as “either a breach of a tax obligation with indicators consistent with intent on the part of the taxpayer or a breach that cannot be explained solely by carelessness.”
Careless behaviour is a lack of due care on behalf of the taxpayer that render tax liabilities incorrect. Careless behaviour is distinguished from deliberate behaviour by the lack of intent on the part of the taxpayer to default. ‘Carelessly’ is defined in the Tax Acts as meaning the “failure to take reasonable care”. The test of reasonable care is “whether a taxpayer of ordinary skill and knowledge, properly advised, would have foreseen as a reasonable probability or likelihood the prospect that an act (or omission) would cause a tax underpayment, having regard to all the circumstances”.
Cases should be judged on their merits for the purpose of determining what penalty is appropriate. Although, Revenue appear to have pre-determined the penalty applicable to a case, even prior to the audit commencing. It is understood that only exceptional cases will be considered for reduced penalties and that these cases will require sign off at Assistant Secretary Level. In any event the level of penalties imposed can be appealed to a court.
It may be worthwhile for practitioners to advise their clients operating via personal service companies not already subject to audit to review their position with a view to determining whether any underpayments of tax have arisen. Practitioners may also wish to review their record keeping procedures to bring them in line, if not already so, with the legal requirements and best practice. The differential in penalties between a prompted voluntary disclosure with deliberate behaviour (50% penalty) and an unprompted voluntary disclosure with deliberate behaviour (10%) should provide sufficient motivation in this regard.
Mark Doyle is a director of Doyle Tax Consultants. He is the author of Capital Gains Tax a Practitioners Guide published by Chartered Accountants Ireland.
Tele: 087 2928769
This article first appeared in the August 2013 issue of tax.point.