IR35

IR35 was announced in the March 1999 Budget and became effective from 6th April 2000.

The legislation was designed to deal with “disguised employees”, individuals whom the government believed were taking advantage of a corporate structure when they should have been taxed as any other employee.

The rules only apply to “relevant engagements” – where an individual provides services to a client through an intermediary (a limited company) and, but for the existence of the intermediary, the income would be treated as that of an employee if the individual had contracted directly with them.

The intention of the legislation is that, apart from specified deductions, all money received by the intermediary in respect of the relevant engagements should be treated as paid to the individual in a form subject to Schedule E income tax (PAYE) and Class 1 National Insurance – in effect dividend payments and many business expenses are not allowed:

Effects

Where there is IR35 income and the income exceeds that paid to the worker as salary (after the deduction of certain expenses) the excess will be deemed to be salary subject to PAYE and NIC in the tax year to 5th April.

It is essential that the correct professional advice is taken in this area as failure to correctly account for PAYE & NIC can result in significant penalties and interest.

The intermediary will be allowed to deduct certain expenses in respect of IR35 income, specifically:

Below we have devised the answers to frequently asked questions regarding IR35

Frequently Asked Questions

Q1. How do I know if I am in disguised employment and so subject to the IR35 rules?

It is essential that you appoint a professional adviser to undertake a detailed review of your actual working arrangements as well as the written terms and conditions of your contract with your client, the professional adviser will critic your overall arrangements and advise you of your likely IR35 status. This is usually achieved through the completion of a comprehensive questionnaire in addition to reviewing the terms and conditions of your contract.

Q2. What are the main factors that are taken in to account in determining if I am subject to the IR35 rules?

Decisions of the courts over the years have established a number of key factors to be considered including:

Control – a worker will not be an employee unless there is a right to exercise control over the worker. This maybe a right to control what work is done, where or when it is done or how it is done

Substitution – personal service is an essential element of an employment contract. A person who has the freedom to choose whether to do the job himself/herself or hire somebody else to do it for them, or can hire somebody else to provide substantial help are strong indicators of Self Employment.

Mutuality of Obligation (MOO) – within a contract there are various mutual obligations – the obligation to perform and be paid for performing would form part of any contract – but the mutual obligations needed for a contract of employment to exist consist of more than this, there needs to be an obligation to offer and an obligation to accept future work.

Financial risk – an individual who risks their own money by, for example, buying assets needed for the job and bearing their running costs and paying for overheads and large regular quantities of materials, is almost certainly self employed. Financial risk could also take the form of quoting a fixed price for a job, with the consequent risk of bearing the additional costs if the job overruns.

Q3. What do the above points mean in practice?

Each case is looked at on its own merits but we have included below two examples that illustrate the more obvious differences between employment and self employment (ie being subject to IR35 and being outside of IR35 respectively)

Frequently Asked Questions

Example 1

Janet’s working arrangements can be summarised as follows;

Although Janet receives no employee type benefits from the client and has a shorter notice period than the client’s own employees she will be regarded as being in disguised employment for IR35 purposes.

Example 2

John’s working arrangements are as follows;

Although John has to abide by Health and Safety rules applying to all workers on site, he is not subject to the same disciplinary procedures as the clients own employees.

In the circumstances you would expect John’s assignment to be outside of the IR35 legislation.

Frequently Asked Questions

Q4. I thought that as long as the written contract was “IR35 friendly” I would be outside of the IR35 legislation?

This is not correct. The courts attach as much weight to the real working arrangements as to the written terms. Where the written terms are not reflected in the working arrangements the contract may be considered as a sham so it is important that the written terms truly represent the actual relationship

Q5. My contract includes a “substitution clause”. I thought that this meant that I would be outside of IR35?

Not necessarily. Where a contractor has a real right to send a substitute worker then this is almost certainly conclusive evidence that they are outside of the IR35 legislation, but the right must be that of the contractor. Where the substitution clause gives the client an unqualified right to decide if a substitute is accepted or not, the right belongs to the client and not the contractor. Where the contractor does have a right of substitution then he/she must also be responsible for paying the replacement worker.

Q6. What does it mean if I am subject to the IR35 rules?

It means that your limited company must apply PAYE to your fee income from that assignment subject to a fixed 5% allowance for expenses and any other allowable employee expenses.

Q7. What are the main advantages of being outside the IR35 legislation?

If you satisfy the conditions for being outside the IR35 legislation, part of your income may be distributed in the form of dividends rather than remuneration. This generally results in lower tax and national insurance contributions. Depending upon your circumstances you may also qualify to claim tax relief on additional business expenses.

Q8. If I pay myself outside ofthe IR35 legislation but HMRC concludes that I am in “disguised employment” could I have a liability?

Yes. The tax office could require you to pay the arrears plus interest. They may also impose a penalty if they feel that you have been negligent in arriving at an opinion. If you have taken proper professional advice regarding your IR35 position and followed that advice then it is unlikely that HMRC will view you as being negligent.

Q9. How can I protect myself against a costly IR35 enquiry

We have teamed up with Caunce O’Hara, who are specialist insurance brokers to the contracting market, and put together a comprehensive IR35 review service and professional fees insurance package to help protect our clients against unexpected legal bills, see our Insurance Page for more details

Q10. If I am considered outside IR35 on one assignment, will I always be outside IR35?

No. Every separate assignment must be assessed on its individual merits. It is possible to be subject to IR35 on an assignment even though other assignments are considered to be outside of the rules. This could be the case where a particular client has a high degree of control over the way in which the services are provided.

Q11. What if I have further questions on IR35 related matters?

Please contact one of our professional advisors who will be happy to answer any questions you may have.

Amendments to IR35 (Intermediaries Legislation)

The government announced recently that the IR35 rules are to be changed to ensure that the legislation applies to office holders or anyone regarded as an office holder for tax purposes. This follows media criticism of public bodies using personal service companies in situations where it was not always clear that IR35 applied.

Under existing rules, the IR35 legislation applies to someone acting in the capacity of a disguised employee and it has been argued that someone holding an office, such as a director or company secretary, may be outside the definition of 'employee' and therefore outside the scope of IR35. The new rules, likely to be introduced from 6 April 2013, clarify that IR35 applies to office holders as well.

As currently drafted, however, the definition of an office holder is fairly widely drawn and as well as covering working as directors etc, is likely to include any worker holding a client management role unless the role is solely linked to a particular contractor project. For example, a HR consultant who has operated in a consultancy capacity outside of IR35 for several clients is asked to provide personal cover for a client's HR manager on three months maternity leave. On the basis of the new rules, that engagement could now be regarded as subject to IR35.

As ever, we will have to see how the new rules are interpreted in practice but we would advise any contractor taking on a client managerial role or office to seek professional advice.

Arrangements Made By Intermediaries

1. In chapter 8 of Part 2 of ITEPA 2003 (application of provisions to workers under arrangements made my intermediaries), in section 49 (engagements to which Chapter applies), in subsection (1), for paragraph (c) substitute -

"(c) the circumstances are such that -

(i) if the services were provided under a contract directly between the client and the worker, the worker would be regarded for income tax purposes as an employee of the client or the holder of an office under the client, or

(ii) the worker is an office-holder who holds that office under the client and the services relate to that office."