Service Company Subsidiaries, A Sting in the Tail?

The vast majority of professional practices that operate through the medium of a partnership have at least one service company subsidiary. This might be a legacy from the days of profit related pay or more recent structuring, perhaps coming out of the transfer pricing compensation adjustments legislation.  Whatever the reason many professional practices have their staff employed by a legal entity other than the main partnership.  Although tax efficiency could accrue (that is until Finance Act 2014!) the structuring came at a compliance cost.  Most firms found the compliance cost was a trifle compared to the benefits received.  The VAT side of HMRC may be found to be a further cost, for both the present and the past.

Presently Customs are routinely reviewing cases where the input VAT on staff entertaining has been recovered by the main partnership. The logic being that staff entertaining is recoverable.  HMRC are countering this by considering the legal form and highlighting where the main partnership doesn’t have any staff and therefore can’t recover staff entertaining.  For the present this is a simple matter to correct.  Either the supplier can invoice the service company or the main partnership recharge down to the service company.  However it is not so easy to get these things done retrospectively.  With HMRC able to review back a number a years therein lies the possible additional compliance cost.