In the 1999 budget, the Chancellor announced his intention to tackle tax and NIC avoidance through the use of personal service companies. This was the beginning of IR35.
Prior to IR35 many people elected to use a limited company structure to avoid PAYE and NIC. A person could be paid by their employer through their Limited Company reducing their tax liability and also allowing the employer to avoid paying unnecessary employers NIC.
It was deemed that IR35 would assist in preventing this practice and remove the opportunity for any avoidance of tax and national insurance by the employees and their employers using limited companies as a tax vehicle.
Currently the Inland Revenue’s definition of a company of this nature is as follows “the legislation may affect any kind of intermediary so no particular intermediary will be defined in the legislation.”
This wholly inadequate definition only can suggest the Inland Revenue is unclear how to interpret IR35.
The Inland Revenue provides guidelines online designed to assist people understand more clearly what IR35 is and how it can affect them www.hmrc.gov.uk but even using these guidelines as a rule of thumb is still not a guarantee of IR35 safety.
IR35 simply means a person who is acting as an employee should be careful and seek advice prior to setting up a Limited company as a contractor. Umbrella companies are equally affecting under IR35.
Broadly speaking the following factors will help to prove if you either inside or outside the IR35 regulations.
Control: The only control is over the quality of work, not such areas as hours worked or equipment used.
Price: The price is fixed for the duration of the contract and it is therefore the contractor who bears the financial risk of a possible loss.
Contracts: You have been working on a number of unrelated contracts over a relatively short period of time.
Substitution: This is known as the “Substitution rule” and refers to the fact that you can if necessary supply a substitute to do your work, or employ others to help complete the task at your own cost.
Other areas to consider are:
Provision of equipment: A self-employed contractor generally provides whatever equipment is needed to do the job. The provision of significant equipment (and/or materials) which is fundamental to the engagement is of particular importance. For example, where an IT consultant is engaged to undertake a specific piece of work and must work exclusively at home uses the worker’s own computer equipment that will be a strong pointer to self-employment. However, where a worker is provided with office space and computer equipment that points to employment, the fact that a worker might occasionally choose to do some work at home using his or her computer does not change that (many employees do just that).
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.
Opportunity to profit from effective Management: a person whose profit or loss depends on his capacity to reduce overheads and organize his work effectively may well be self-employed. People who are paid by the job will often be in this position.
Part and Parcel of the Organization: establishing whether a person becomes ‘part and parcel’ of a client’s organization can be a useful indicator in some situations, for example, someone taken on to manage a client’s staff will normally be seen as part and parcel of the client’s organization and is likely to be an employee.
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, and 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.
Length of Engagement: long periods working for one engager may be typical of an employment but are not conclusive. It is still necessary to consider all the terms and conditions of each engagement. Regular working for the same engager may indicate that there is a single and continuing contract of 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 intentions of the parties will then be the deciding factor in employment status.
Given the list of factors mentioned above it is tempting to try to determine a person’s employment status by adding up the number of factors pointing towards employment and comparing that result with the number pointing towards self-employment. The Courts have specifically rejected that approach.
When the detailed facts have been established the right approach is to stand back and look at the picture as a whole, to see if the overall effect is that of a person in business on his own account or a person working as an employee in somebody else’s business. If the evidence is evenly balanced, the intention of the parties may then decide the issue.
The Inland Revenue has looked at a number of standard Agency contracts and has, as expected, suggested that such contracts fail IR35.
The Revenue will only consider whether specific contracts fail the test and will not give any clearance on standard contracts.
The conclusion of all of the above is that if you sign a standard agency contract you are likely to fail IR35. Even if you get a contract worded differently, the Revenue will look at the facts behind the contract.
There is no way around IR35 unless you change your working practice and contract, but there are ways to maximize your earnings in the face of IR35.