What is IR35?
Personal service company legislation of IR35 as it is more commonly known has been in existence since 1999. The application of the legislation has proved to be a very grey area and after some 15 years it is still an area causing problems for the Government, HMRC and taxpayers alike. The actual tax collected under IR35 has been a mere drop of the tax that the Government expected it to raise in its initial assessments.
Summary of the rules
The rules apply to each individual engagement where:
- A worker provides services under a contract between a client and an intermediary i.e. (the personal service company); and
- But for the presence of the intermediary, the income arising would have been treated as coming from an office or employment held by the worker under the existing rules used to determine the boundary between employment and self employment for income tax and NIC purposes.
Where the engagement falls within the new personal service rules it is classed as a relevant engagement and:
- The intermediary will operate PAYE on payments of salary to the worker during the year.
- If at the end of a tax year, the total worker’s emoluments subject to PAYE, amounts to less than the intermediary’s income from all that workers relevant engagements, then the difference will be deemed to have been paid to the worker as salary on 5th April, and further tax and NIC will be due.
Where salary is deemed in this way:
- Appropriate deductions will be allowed in arriving at corporation tax profits ie:
- All expenses otherwise eligible for deduction under the normal Schedule E rules, although in practice these are very limited in scope;
- Any employer pension contributions made to an approved scheme which are allowable under the normal rules;
- A further flat rate 5% of the gross payment to cover running costs
- Employer’s NIC paid during the year and due on the deemed payment
- No further tax or NIC will then be due if the worker later withdraws the money from the company.
How to determine self-employment of employment status
In deciding whether a worker would have been an employee if engaged directly by the client it is necessary to establish the terms and conditions of the engagement.
If there is a written contract, the Revenue and the Courts cannot look beyond the contract unless the parties subsequent conduct can be shown to have amounted to an agreed addition to, or modification of, the original contract. The courts will interpret the written contract in the light of the circumstances surrounding the making of it. However the contract will be ignored by the Court if the parties do not intend to create the legal rights and obligations that they give the appearance of creating i.e. if the contract is a sham.
There is no statutory definition of “employment”. However, the question of employment status has come before the Courts on numerous occasions. The approach taken by the Courts has been to identify factors which help to determine if a particular contract is a ‘contract of service’ (employment) or a ‘contract for services’ (self-employment). These relevant factors include:
Control – A worker will not be an employee unless there is a right to exercise ‘control’ over the worker. This may be a right to control ‘what’ work is done, ‘where’ or ‘when’ it is done or ‘how’ it is done. Actual control of this sort is not necessary – it the right of control that is important.
The right to get a substitute or helper to do the job – Personal service is an essential element of a contract of employment. A person who has the freedom to choose whether to do the job himself or hire somebody else to do it for him, or who can hire someone else to provide substantial help is probably self-employed.
Provision of equipment – A self-employed contractor generally provides whatever equipment is needed to do the job (though in many trades, such as carpentry, it is common for employees, as well as self-employed workers, to provide their own hand tools). The provision of significant equipment (and/or materials) which are fundamental to the engagement is of particular importance.
Financial risk – An individual who risks his own money by, for example, buying assets needed for the job and bearing their running costs and paying for overheads and large quantities of materials, is almost certainly self-employed.
Basis of payment – Employees tend to be paid a fixed wage or salary by the week or month and often qualify for additional payments such as overtime, long service bonus or profit share. Independent contractors, on the other hand, tend to be paid a fixed sum for a particular job. Payment “by the piece” (where the worker is paid according to the amount of work actually done) or by commission can be a feature of both employment and self-employment.
Opportunity to profit from sound management – A person whose profit or loss depends on his capacity to reduce overheads and organise his work effectively may well be self-employed
Part and parcel of the organisation – Establishing whether a person becomes ‘part and parcel’ of a client’s organisation can be a useful indicator in some situations
Right of dismissal – A right to terminate an engagement by giving notice of a specified length is a common feature of employment. It is less common in a contract for services, which usually ends only on completion of the task, or if the terms of the contract are breached.
Employee benefits – Employees are often entitled to sick pay, holiday pay, pensions, expenses and so on. However, the absence of those features does not necessarily mean that the worker is self-employed – especially in the case of short-term engagements where such payments would not normally feature.
Personal factors – In deciding a person’s employment status it may sometimes be necessary to take into account factors which are personal to the worker and which have little to do with the terms of the particular engagement being considered. For example, if a skilled worker works for a number of clients throughout the year and has a business-like approach to obtaining his engagements (perhaps involving expenditure on office accommodation, office equipment, etc) this will point towards self-employment
Intention – It is the reality of the relationship that matters. It is not enough to call a person “self-employed” if all the terms and conditions of the engagement point towards employment. However, if other factors are neutral the intention of the parties will then be the decisive factor in deciding employment status.
Business Entity Tests
Via their web site HMRC offer a series of tests for the contractor to identify if (in their view) IR35 applies or not. Although HMRC may refer to these tests in correspondence, there is no legal requirement for the contractor to take these tests and these tests carry no weight in law.
We believe that avoiding IR35 should be possible for most contractors. The key is to:
- understand the law; and
- arrange your affairs so that you fall outside of the legislation.
If you are unsure whether IR35 affects you or would simply like to discuss IR35 further please contact us.