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IR35 Explained | Return to menu |
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The provision of personal
services through intermediaries. IR35 - Home page Is it worth the risk? |
These regulations took effect from 6 April 2000, and will apply to
anyone:Many businesses need to take on specialist consultants for relatively short contracts. In order to avoid incurring potential PAYE/NI tax problems in connection with the engagement, they understandably insist that these individuals operate through either an intermediary company or partnership. The client then contracts directly with the intermediary. The arrangement seemed to suit everyone, until the Inland Revenue became aware that many of the consultants operating through intermediaries were enjoying a significant tax advantage. In the case of incorporated intermediaries they could take most of their earnings out of their companies by way of dividend and avoid paying significant levels of National Insurance tax. IR35 was introduced by the Inland Revenue to stop this practice. Whatever you may think of the new regulations, and feelings continue to run pretty high over whether it is a fair tax, the reality of the situation is that the tax is law for the moment and has to be complied with. The first step you need to take is to work through the following flowchart to see if IR35 applies to any of your own engagements since 6 April 2001. The flow chart is neither conclusive nor exhaustive, but if you feel there is any possibility that the new IR35 rules may affect you, then seek our advice sooner rather than later. |
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| Does IR35 apply to you? |
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| Employment Status | Part of the process of deciding whether IR35 applies to a particular
situation, is to take a look at the 'employment status' of the worker
involved. The status of a worker can be judged to be one of either: Status is decided by considering the nature of the overall working relationship between the worker and the client. It is relevant to IR35 because the new regulations will only apply to engagements where the worker would be deemed to be an employee of the client, if it were not for the presence of the intermediary. There is no statutory definition of what constitutes employment, so status is determined by reference to a series of standard 'indicators of employment' that have arisen from case law. The Inland Revenue have published several documents and guides that explain their view on how employment status should be determined. They can be obtained from your local tax office, or downloaded from their website (www.inlandrevenue.gov.uk). We list the main status indicators below. Their application to a particular situation is very subjective, and where there is the opportunity for a difference of opinion to arise, there is also the certainty there will be confusion. One should exercise caution in deciding which of the indicators apply to your engagement, and be prudent in their interpretation. Taxpayers tend to be overoptimistic when judging employment status and unrealistically biased towards self-employment for obvious reasons. No one likes paying taxes. You should try to be objective when you look at your employment status. If you have any doubts, then seek our opinion. You also have the option of applying to the Inland Revenue directly for a decision on the employment status of a worker in a particular engagement. It should be remembered that it is only their opinion that matters at the end of the day. Factors that should be considered when deciding the worker's employment status include: |
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| Right of control | Where the client has more control than the
worker over what work is to be done, where, when and how it is to
be performed, then the status will be more like one of employment.
When a worker can come and go as they please, decide how, when and
where the agreed work to be undertaken is going to carried out, then
status leans towards self-employment. |
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| The right to substitution or appoint helpers | It is a normal characteristic of self-employment
that the worker, at his or her own cost, has the right to arrange
a substitute to take their place, or to appoint further helpers to
get the work done. These options are not normally available
to employees. The Inland Revenue has indicated that where a worker has a contractual right to arrange a substitute or helper, but must first seek the permission of the client to do so, then this will undermine the ability of the intermediary to claim that self-employed status applies in this case. |
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| Provision of equipment | It is normal characteristic of employment,
for the worker to be provided by the client with the equipment, desk
and office space, they need to carry out the job in hand. Conversely,
it is indicative of self-employment when an individual works from
their own office (including home) and use their own personal equipment
and tools. It is interesting to note that the Inland Revenue have pointed out that a worker who chooses to use his or her own equipment, in preference to those supplied by a client, will still be viewed as having an employed status. |
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| The basis of payment, and is there financial risk? | If the worker is remunerated at a contract
rate (by the hour/day/ etc) and is not at risk of making a loss on
the outcome of the engagement, then this kind of arrangement is more
indicative of employment. On the other hand, a self-employed person
is more likely to arrange a fixed contract price for completion of
a specific task. They are also in a position to profit from better
management of the task in hand. It is very easy to overlook the very real risk the intermediary faces in the event of their client not paying their bills, perhaps through insolvency. The current Inland Revenue view is that invoicing and nonpayment is not a significant factor in IR35 status decisions. In these times of economic uncertainty, one could present a much better case that this risk deserves higher recognition. Business risk in this sense, certainly has its precedents in case law. |
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| Part and parcel of the organisation | The more integrated the worker becomes in
the management structure of the client, the more likely it is that
he or she will be viewed as employed. The more the client holds out
the worker to be a separate third party, both internally and externally
to its own clients, the more justifiable a self-employed status becomes. |
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| Length of contract | There are no set rules, but the longer a
worker stays in a contract with the same client, the more likely that
role assumes one of employment. The Inland Revenue's guidance notes
make reference to contracts as short as one month still falling within
the scope of IR35. In contrast, the current rules for determining
if overnight and travel expenses are allowable for tax purposes, uses
a two year period to define what is, and what is not, a temporary
work place. |
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| Agency-workers | The Inland Revenue have indicated that where
there is an engagement involving the intermediary contracting with
an employment agency to place a worker with a client, using a typical
'standard agency contract', and the arrangement lasts for more than
one month, the engagement is to be viewed as employment. Have no illusions. It is likely that most long term contracts (more than a month) operated through an agency will be caught by IR35. There are organisations offering IR35-proof agency contracts. The basis of IR35 avoidance hinges on the careful wording and construction of the legal terms of the contracts between the intermediary-agency on one hand, and then the agency-client on the other. Whether the Inland Revenue will accept these arrangements remain to be seen. The impression one gets is that they will fail simply because the actual day-to-day working relationship between worker and client will not match those laid down in the contracts. The contract may escape but the reality of the working relationship won't. |
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| Mutuality of contract |
If the client is obliged to provide work, and/or the worker is also
obliged to accept work, then this is a strong indicator of employment.
If the client and worker have no such mutual obligations to
each other, then this is an indicator of self-employment. The Inland
Revenue were keen to underplay the significance of mutuality of
contract in their early guidance notes. But in a recent Judicial
Review of IR35, the judge emphasised that mutuality would be
an important determining factor in employment status decisions. |
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| The intentions of the parties | It is always good business practice to have
a written contract in place, and in the event that all other indicators
of employment status are equal, then the intentions of the contracting
parties will decide the case. There has been a proliferation of commercially
available 'IR35-friendly' contracts. If you intend to use such contracts
then you must ensure that the terms written into the contract, reflect
the actual reality of the working arrangements you undertake in the
fulfillment of the engagement. The Inland Revenue have the right to
look at the real substance of the working relationship, not just the
legal form. Many taxpayers have come to grief in the past, because
they relied upon 'contrived tax avoidance' contracts that have failed
to stand up to scrutiny. |
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| It should be noted that no significance should
be placed in the order in which we have placed the above indicators
of employment status. Time and time again the Courts have emphasised
how important it is to take into account the balance of all the relevant
factors of employment status, before attempting to reach a decision
on an individual engagement. You would not be alone in thinking that the very subjective approach to making employment status decisions deserves more attention and clearer guidelines from the Inland Revenue. Regrettably, every attempt to improve the uncertainty surrounding IR35, has only served to confuse matters even more. This therefore means that, you as the taxpayer, have to exercise even more care in judging whether a particular engagement may, or may not, fall within the scope of IR35. The next chapter highlights why getting it wrong, could be very costly indeed! |
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| The
IR35 quick-calculator An estimate of your potential IR35 tax liability you may face at the close of the current fiscal year on 5 April 2003. |
If you have any relevant IR35 income in the year ending 5 April 2003,
then you may find the following quick calculator a useful exercise
to carry out every three months or so, during the year. It will allow you
to determine if you are accruing a potential IR35 tax liability. There are
steps you can take to reduce the impact of the new regulations, but these
have to be acted upon before the 31 March 2003 to be effective. Print off this page, and enter your year-to-date figures in the left hand column. The figures on the right are given as a guide to show you how the 'calculator' works. One point to remember. The relevant income for IR35 purposes (i.e. the £60,000 in the example given below) is calculated on a cash received basis. For the purposes of your calculation, you should only include sales receipts taken in the period 6 April 2002 to 5 April 2003. You should not include the sales invoices you will probably raise during March 2003, unless you receive settlement payments before 5 April 2003. Tax planning tip: Arrange your affairs so that March 2003's invoices are not paid until after 5 April 2003.
Although this is a rough guide only, it does permit you to keep track of the IR35 liability that may arise next April. If the 'net profits' is greater than zero, then a charge to IR35 tax is likely to arise. You would benefit from talking to us well before 31 March 2003 to explore ways of reducing the impact of IR35. If the 'net IR35 profit' is negative, then it is unlikely a charge to IR35 tax will arise. In our example, the net IR35 profit figure amounts to £26,551. At this stage, we are forecasting a fairly large additional IR35 tax charge of £10,570, which is calculated thus:
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| Points to note | Most people are surprised at the size of the additional IR35 tax bill
of £10,570. This is why it is so important for individuals to keep
track of where they stand during the year. To leave it until April each
year may be too late. The calculation of R35 tax will vary significantly from worker to worker. Factors such as the worker's tax code and the amount of gross pay already paid to date, will all have a bearing on the final amount of tax payable. Don't leave it to the last minute! If IR35 applies to you, then this is one area of tax planning that you cannot afford to leave to the end of the year. Most of the options taxpayers have available to them to reduce the impact of IR35, must have been carried out well before March 2003. Does the Deemed Payment have to be paid on the 5 April 2003? Answer "No". The Deemed Payment lives up to its name, in that the intermediary does not actually have to make the salary payment to the worker. The tax is a 'soft' penalty applied against the intermediary for not paying over the majority of the income arising from IR35-type work as salary to the worker. Tax tip for companies: To ensure that the intermediary obtains early corporate tax relief for the IR35 Deemed Payment, if the accounting year end is between October 2002 and March 2003, it will be worth considering paying a bonus to any IR35 workers to neutralise the forecast IR35 Deemed Payments that could arise on 5 April 2003. Clearly the closer the year end falls to 5 April 2003, the more attractive this option becomes. |
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