The Irish Revenue has rolled out its Project on Professional Service Contractors nationwide. Mark Barrett of Moore Stephens Nathans explains the origins of the project, the impact of its expansion and the issues practitioners need to look out for when advising clients.

Introduction

At the Irish Tax Institute/Revenue Joint Conference in Limerick on 7 June 2013, Revenue made a presentation on the roll-out of a National Revenue Project on Professional Service Contractors. This national project has developed from a sectoral project in the South West Region, which had been evolving for over four years and has been running at an intense level since September 2012.

Origins of the Project

The project has its roots in the contracting industry that serves the pharmaceutical industry in Munster. For many practical reasons, pharmaceutical companies have a requirement to be able to upscale and downscale their human resources depending on the projects or activities being carried on in their plants at any particular time, without having to retain a full-time staff to support the projects. To meet this requirement, a contracting structure has evolved in the industry, which typically involves the following parties:

Pharmaceutical company
Main engineering contractor (intermediary)
“Single-employee” engineering consulting company
“Contractor” (director/employee of “single-employee” company)

This represents the basic structure, which can vary depending on the parties involved and can include an additional layer or intermediary. In all situations, there will be at least one corporate entity between the contractor ultimately providing the services and the pharmaceutical company or client. The focus of the project to date has been on the failure of the “single-employee” companies to account for tax properly on the payment of expenses to the contractor.

Treatment of Expenses

There would appear to have been an approach adopted by some contractors that resulted in tax-free payments of expenses over and above those permitted. In many situations, Revenue deemed that excessive expenses had been claimed by contractors who had carried on their business on the assumption that travel between their home/registered office and a client’s site was a legitimate business expense that could be reimbursed to them on a tax-free basis. The discovery by Revenue of this approach to the treatment of expenses resulted in a number of audits, with yields typically of €60,000 – €70,000. As a result, Revenue escalated the project in the South West Region in the period from September to December 2012 and issued several hundred Revenue audit notifications. These audits, combined with Revenue’s belief that the incorrect treatment of expenses is not limited to the South West region, have led Revenue to roll out the project nationwide.

Experience to Date

Over the years, I have been involved in several Revenue projects, including amnesties and investigations into bogus non-resident accounts, offshore accounts, single-premium policies etc. This generally involved dealing with individuals of pension age who had to address tax issues dating back to the 1970s and 1980s. Typically, there were funds available to discharge any liabilities arising. This contractor project is different in that the individuals involved tend to be professionals in their 30s and 40s, often with young families and with properties in negative equity. Many of these have seen their life savings swallowed up in settlements and have also entered into instalment arrangements to discharge the liabilities arising.

These cases are very emotive, in particular where individuals carried out their business activities in the honest belief they were properly conducting their tax affairs only to find themselves exposed to significant tax, interest and penalties. The project is also different from previous projects in that generally individuals were keen not to discuss or publicise their difficulties with Revenue and cases were dealt with on a stand-alone basis. In the current project, Revenue was not just dealing with individual audit settlements. Because many of the contractors affected worked together on client sites, communicated using modern media platforms and often had similar tax agents, the project was essentially being run in a “goldfish bowl”, where the policies and treatment being adopted by Revenue were generally known to all parties affected. This in turn made dealing with settlements on a case-by-case basis almost impossible, as every decision made was potentially setting a precedent.

Guidance

This “goldfish bowl” effect meant that it became very difficult for caseworkers in Revenue to close out audits as there was a lack of clarity on the rules and procedures to be adopted. For this reason, after representations made by the South West Branch Network, a clarification letter issued from Revenue in the South West Region on 22 January 2013. This letter can be viewed in full on the ITI website and it outlined some key elements of the strategy being adopted by Revenue in these cases:

The facility to make a qualifying disclosure would be available in these cases and is encouraged by Revenue.
Where an unprompted disclosure is received, a penalty of 10% would apply, whereas a prompted disclosure made after receipt of a Notice of Audit would be penalised at 50%, and failure to make a complete disclosure would increase the penalty to between 75% and 100% of the tax underpayment. Revenue took the view that, because of the nature of the under-declarations, the appropriate category of default was that of deliberate behaviour. Revenue clarified that where exceptional circumstances are claimed, a special case would need to be formally made to the Revenue caseworker, who would then make a recommendation for decision at Assistant Secretary level. It is understood that where the only issue arising in an audit is an incorrect treatment of expenses based on travel from home to work, the appropriate level of penalty would be 20%.
The period that would be subject to audit would be the four complete years preceding the date of issue of the Notice of Audit. This clarification resulted in some subsequent confusion, which is addressed further below. It is worth noting that a tax default involving fraud is not subject to any time limit and the restriction to four years was applied by concession by Revenue.
Revenue stated that it would take a reasonable approach to the level of detail required. In discussions through the Branch Network, the role of reputable advisers and members of the ITI was acknowledged, and it was stated that disclosures received from such members would not be subject to undue scrutiny where the figures come within the range of those generally allowed for within the scope of the project. The exact details of these parameters were not included in the clarification letter.
Importantly from an industry perspective, Revenue reserved its position in relation to the overall structure of remuneration and did not express an opinion on “whether the arrangements we encounter are valid, that is, whether the company directors should more properly be regarded as direct employees of the entity awarding the contract”. It is clear that this has not been the focus of the project to date.
In discussions through the Branch Network, it was also clarified that disclosures would be accepted where no re-grossing of the net payments was applied. This was an important clarification as it appears that some agents had filed disclosures on this basis and Revenue caseworkers had been concerned by the need to apply a consistent and fair treatment. However, it was made clear that this acceptance of a non-re-grossing position was not intended to facilitate directors providing loans to their company that could subsequently be repaid tax-free. In essence, if a director attempted to organise his or her and the company’s affairs in this manner, Revenue would seek to regross the net payments that the individuals had received.

Common Issues

Treatment of travel expenses

One of the issues that has given rise to most difficulty in these audits has been the lack of clarity on what constitutes an allowable travel expense. Many contractors operated under what they considered to be industry norms. There also seem to have been some commonly held views on the level of expenses that would be acceptable to Revenue, e.g. provided that 70% of a company’s turnover was ultimately taxed in the hands of the contractor, it would be considered to operate within tolerable limits, even though it did not have vouched expenses to support this level of expense deduction.

Revenue guidance on expenses, including Statement of Practice IT/2/07 and leaflets IT51 (Employees’ Motoring/Bicycle Expenses) and IT54 (Employees’ Subsistence Expenses), did not give contractors the clarity that they needed on the treatment of expenses particular to their industry’s work practices, such as working from a home office, travel from a home office to sites, travel between client sites and a main contractor’s offices, treatment of a series of short-term contracts, travel on foreign assignments etc.

As part of the rolling out of this national project, Revenue issued Tax Briefing, Issue 3, July 2013, “Reimbursement of Travel and Subsistence Expenses by Intermediaries”. This contains a series of examples aimed at bringing clarity to the entitlement to claim expenses by employees/directors of contracting companies. At the time of writing, the Tax Briefing has just issued, and from an initial review, it contains some examples indicating that Revenue does not believe that it is acceptable to claim a travel expense for journeys from a home office in any circumstance, which does not cater for the modern working environment. It also seems to preclude the claiming of subsistence expenses by contractors who frequently move between sites; this would go against established Revenue practice, which allows subsistence payments for up to 56 nights when taking up a new place of work, or up to six months with Revenue approval, as catered for in IT54. The ITI is making a written submission to Revenue on these issues, which will be tabled for discussion at TALC, and this will hopefully have progressed by the time that this article is published.

Employment of family members

The treatment of payment of wages/salaries to spouses and other family members by companies is a common feature of these cases, and Revenue has sought to tax payments in the hands of the main director/employee. Revenue has taken a view in some cases that the method of payment (e.g. whether the payment went into a spouse’s own personal account) is a deciding factor, whereas the facts and circumstances in each case need to be considered.

“Four-year” period

In the clarification letter issued by the South West Region, it was stated that:

“In the normal course, where an audit is required, it will cover the four complete years preceding the date of issue of the notice of audit. Extension to other years will, as in all audits, depend on the circumstances of the case, but will be unusual.” (In cases of this type or within this category.)

My understanding of this wording is that the period to be covered by a disclosure is the four-full-year period ending with the last accounting period before the date on which the disclosure was made, provided that the filing date for the last year has passed.

Entity making the disclosure

As with most audits of companies owned by proprietary directors, audit letters have been issued to the main director in addition to the company. In all of the situations that I am aware of, where the only issue has been the treatment of expenses, Revenue has accepted the disclosures by companies, without a separate disclosure having to be made by the individual contractors.

Practical Difficulties

From a tax practitioner’s perspective, these disclosures have been very labour-intensive, and many have taken several months to complete due to the following reasons:

The “goldfish bowl” effect has meant that Revenue has to be consistent in its approach, and this has removed some of the caseworker discretion that is often relied on to bring audit settlements to a close on a timely basis.
The scaling up of the project has meant that new caseworkers without the necessary industry knowledge have been brought into the project.
In situations where taxpayers have felt that the tax liability did not result from deliberate behaviour (due, for example, to reliance on professional advice, a misunderstanding of the technical position relating to home office expenses etc.), applications are made to the Assistant Secretary for a determination.
In some cases the details in the disclosure have been the subject of verification checks or confirmation from third parties.
Finally, in many situations, given the profile of the individuals and the level of settlements involved, it has been necessary to interact with the Collector-General’s Office to complete Phased Payment Application forms (PPA1) and prepare statements of affairs to establish an inability to pay.

Penalty Regime

The approach taken by Revenue to date in treating all prompted disclosures as arising from deliberate behaviour highlights some of the major weaknesses in the penalty regime. The legislation governing Notices of Opinion (s1077B TCA 1997) envisages that where no agreement can be reached with the taxpayer about the appropriate level of penalties payable and “a Revenue officer is of the opinion that the person is liable to a penalty under the Acts, then that officer shall give notice in writing to the person”. The legislation envisages a Revenue official forming an opinion on the appropriate level of penalty based on the particular facts of a case. By taking a position that all cases fall into the category of deliberate behaviour unless there are extenuating circumstances, Revenue is not taking account of the individual facts of each case. Similarly, it is not taking into account that in many situations the contractors were operating within industry norms and were also relying on professional advice. Although there is no doubt that in some situations contractors should have known when a particular tax treatment was “too good to be true”, in my view there is also no doubt that hard cases make bad law, and each case should be judged on its own merits. When the penalty regime was introduced in 2008, Revenue’s view was that there would be only a handful of cases per year where a Notice of Opinion would issue. However, essentially each one of these cases where a 50% penalty is applied unilaterally constitutes a de facto Notice of Opinion. Although there is the opportunity for an individual to appeal a penalty determination to the courts, the cost of doing so is so prohibitive and the hearing is also held in public, which effectively means that there is no realistic avenue of appeal to determinations made by Revenue.

Roll-out of the Project

In light of the number of settlements and the level of the average settlement to date, Revenue has decided to extend the scope of the project in terms of both the geographical regions and the types of industry involved. Audit notification letters have issued in recent months from Revenue Regions other than the South West. While initially these are focused on the pharmaceutical sector, it is understood that other sectors, such as the IT consulting sector, will be included as the project is rolled out. The letters from the other Regions are consistent with those from the South West Region in that they are applying to a four-year period. The ITI has raised a number of concerns in relation to the letters, including seeking that Revenue change the wording specifying that a qualifying disclosure must be notified to Revenue within 14 days in order to get the 60-day period provided for in the Code of Practice for Revenue Audit. As the letters were worded, it could have been interpreted that Revenue required the disclosures themselves to be made within 14 days of receipt of the letter.

The letters also stated that in situations where no disclosure was being made, detailed information was required to be produced to Revenue for a four-year period in a very short timeframe. In response to representations from the ITI, it was accepted by Revenue that where disclosures were not being made, 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. The reconciliation should show the major (5% or more) deductions from gross income, and a note of the higher expenses in the period should also be included.

Conclusion

The main purpose of this article has been to highlight the roll-out of this project by Revenue countrywide across all sectors involving professional service contractors. I would advise all practitioners to review their client base to establish whether they have clients that could be affected by this project and to consider whether it is appropriate to make unprompted voluntary disclosures and avail of the 10% penalty. The way in which these audits are conducted continues to evolve, and the latest development at the time of writing appears to be that Revenue has issued audit investigation letters to several contracting companies in the Cork region, which precludes the ability to avail of the qualifying disclosure provisions under the Revenue Audit Code. My feeling is that this project has a lot left to run in it, and practitioners need to appraise any of their clients that may be affected.