IR35 – Deemed Employment
In the April 2000 budget Gordon Brown, the then chancellor, introduced IR35 legislation. The aim of the legislation was to cancel out any tax or National Insurance (NI) advantages an individual may gain by running their business through an intermediary (Limited Company or Partnership).
But the government faced a dilemma, they want entrepreneurs to set up and build businesses to help grow the economy, but they do not want to lose tax revenue where HMRC feel people are really employed but have set up a “convenient” business arrangement to reduce their tax liabilities. The chart below shows the importance of Income Tax and National Insurance contributions to the overall UK public purse.
Unfortunately, over the years the dilemma between protecting employment tax revenues and encouraging entrepreneurialism has led to a confused and inconsistent application of IR35 by HMRC.
When might IR35 apply?
IR35 only applies to the provision of services not goods. Also, where those services, like engineering services or an IT consultant, are provided by an individual through an intermediary i.e. a partnership or Limited Company, IR35 may apply.
11 tests of IR35
- Control and Supervision
How much control does the client have over the service performed, when, where and how?
- Mutuality of obligation
Is the client under an obligation to supply continuous ongoing work? Continuous ongoing work implies employed status whereas when a task finishes there should be no expectation from the contractor of further work.
- Provision of own equipment
Where the client provides equipment to perform the service this is more in line with employee status, a contractor would normally be expected to provide his own equipment.
- Financial risk
A contractor will normally take all the financial risk involved in providing the services such as buying equipment, hiring helpers and is generally responsible for how their business runs.
- Personal services and providing a substitute
An employee provides their personal skills to an employer whereas a contractor provides services to a client and could put in a substitute to provide that service.
- Basis of payment
Employees are usually paid hourly, weekly or monthly whereas a contractor usually invoices at the end of a job (or staged payments) and bears their own expenses and overheads.
- Exclusivity and length of engagement
Employees normally work for an employer for lengthy periods whereas a contractor usually has several clients with shorter contract duration although HMRC accept working for prolonged periods with one client may not be typical of self-employment but in itself is not conclusive proof of employment status.
Should the contract between a contractor and client prevent the contractor having other clients this will be deemed employment but HMRC recognised a client may insist on a contractor not working with the client’s direct competition.
- Part and parcel of the organisation
Contractors must not be part and parcel of their client’s business, i.e. not on any employee list, not have business cards with their client’s name on it and must not get “staff” benefits such as pension, bonus, benefits like gym membership. Also, any contract with reference to “performance reviews” or “disciplinary actions” would suggest employed status.
- Right of dismissal
It is unusual for a contractor to be dismissed for anything other than a breach of contract. Whereas employees have regulated or contractual notice periods but a contractor would not normally be given a notice period as such but may agree a reasonable mutuality acceptable notice period for concluding the contract.
- Intention of the two parties
A contractor works under a contract for services whereas an employee works under a contract for service. Ideally a contract would be in writing, but contracts can also be oral or implied – but will be taken to be what the parties intended.
A well written contract for services can help with IR35 status but are seen by HMRC more as a “tie breaker” rather than conclusive proof.
- Business like trading
A contractor should have all the trapping of running their own business such as –
Appropriate business insurances in place
Meet Health & Safety requirements
Meet statutory requirements and have appropriate licences in place
Advertise the business
What happens if HMRC deems you to be employed?
Should HMRC deem IR35 applies then the contractor must carry out a “deemed salary / schedule E calculation” for each tax year on deemed income received from relevant contracts. This will be net income (excluding VAT) less 5% allowance to cover the administration costs of the business, in addition to the 5% allowance the contractor can claim direct costs such as travel, computer costs, subsistence, training and sub-contractor costs providing these costs meet the incurred wholly and exclusively on behalf of the business test.
Once the schedule E calculation is reached the contractor will be liable for the income tax and employee NI with the client liable for the employer’s NI on the IR35 captured income.
To protect themselves clients will often only engage Limited company status contractors and to put an additional buffer between themselves and the contractor will only go through a third-party agency.
Government Bodies – 6 April 2017
Prior to 6 April 2017 it was considered an issue for the contractor whether IR35 applied, but after 6 April 2017 Government bodies such as Armed forces, Local government, NHS, schools, Police etc will have the responsibility to decide if IR35 applies to their contractors. This has resulted in many Government bodies reconsidering their contractors position and issuing contracts of employment instead.
November 2017 budget
There has been pressure put on the chancellor to clarify and simplify the IR35 rules in this month’s budget. Hopefully he will, removing a lot of the confusion surrounding IR35.
IR35 is a complex issue, this article is only intended to highlight some of the issues connected with IR35, if you feel your business could be affected by IR35 seek professional advice otherwise your business could face problems in the future and you could pay more tax and national insurance than is necessary.
Burton Mail – Wednesday 08 November 2017. Next month we will look at personal self-assessment tax returns.