Taxation and Professional Contractors

Introduction

Until relatively recently, any professional person providing services of benefit to a large corporate, be it a Bank or multinational company, in Ireland would simply be hired as an employee and taxed through the PAYE system. Subject to occasional Revenue audits on the company, that would be the end of the matter and the employee, assuming he or she was not a Company Director and had no other income, was not even required in many cases to file an Income Tax Return.

Times have now changed however and employers for understandable business reasons are reluctant to take on employees on an indefinite basis with the resulting implications from a HR and employment law perspective and all that this may entail in terms of holiday pay, pension entitlements, statutory redundancy etc.

If the professional person is instead engaged under a “contract for services” as a self-employed person in their own right, the employment law and associated implications are overcome and the contractor is paid based on invoices produced with no deduction of tax at source. This is however by no means an ideal solution either, as recent experience has shown that in many cases, Revenue will still view the relationship between the parties as that between an employer and employee with a risk that on a tax audit they may require the “employer” to pay over the tax that should have been deducted at source on payment to the “employee”.

This is an unacceptable risk to any corporate and a further layer of security is required by insisting that the contractor incorporates their business into a limited company and use that entity as a vehicle by which their expertise and time may be invoiced to the ultimate client.

On receipt of the contracted amount – and of course associated VAT where applicable – the contractors company will pay a salary to the contractor via the PAYE system.

The issues that can arise . . .

In a scenario where for example €100,000 per annum is invoiced and received by the contractors company and an equal amount is then paid out in salary via the PAYE system with appropriate tax deductions at source, no issue arises – indeed in such a situation the Revenue Commissioners gain additional tax because the contractor in many cases will also be the owner of the company and will not be entitled to the annual PAYE credit of €1,650 per annum.

It has come to Revenue’s attention however that in cases such as this, the actual salary paid by the contractors company to the contractor is considerably less than the full amount of fee income that the company receives.

Instead the company finds itself in a position that before it can pay a salary it has first to defray various other expenses incurred such as:

• Financing      the cost of an office including matters such as an ISDN line, laptop and      the cost of Directors mobile phone expenses incurred and wholly related to      the conduct of the company’s business. Issues can arise when that office      is at the registered legal address of the company and that also happens to      be the home address of the Director.

• Various      motor expenses incurred by the company based on claims made by the Company      Director for use of his or her own motor vehicle etc. on company business.      Although the mileage rate claimed is usually well within published      standard public sector rates, disputes can arise with Revenue as to what      exactly constitutes genuine “business” mileage which can be reimbursed in      this way and what constitutes non business mileage which cannot be      reimbursed in this way. An example of non business mileage is travelling      to and from work and a particular issue that arises is where exactly is      the place of work of the employee in specific scenarios.

If we now change the facts outlined in the last example and assume that instead of the company paying out the full fee income of €100,000 as salary, it instead incurs €15,000 of motor expenses and €10,000 of other costs it can then only pay out €75,000 as salary. In that case the potential loss to Revenue is the €25,000 drop in salary at the combined marginal income tax rate of 52% giving a total drop in tax of close to €12,750.

Revenue interest in such cases

Given the situation as set out above, it can be seen why Revenue would have an interest in ensuring that only genuine business expenses are defrayed by such professional service companies and in particular that only legitimate reimbursement of motor expenses related to business mileage takes place.

Undoubtedly, practitioners would argue that the worst case outcome outlined above is unlikely to occur very often in practice but nonetheless this is an area where Revenue have repeatedly stated that there will be an increasing number of tax audits in the future. Given the current precarious state of the Exchequers finances, a look back tax audit over a period of four years would not be uncommon and for that reason a review of current practices in place with clients may be warranted.