What is IR35 and how might it affect me?
I have heard about IR35, what is it?
As a contractor it is imperative that you are aware of IR35 legislation, what it entails and the risks involved. IR35 affects everyone in the contracting business. In a Nutshell, IR35 legislation tries to tax your company income as employment income meaning that almost all of the tax advantages gained will be lost if you fall foul of IR35.
Who does IR35 legislation affect?
IR35 affects contractors working through a limited company. The Intermediaries Legislation (IR35) came into force in April 2000. It was designed to deal with "disguised employees", individuals that the government believed were taking advantage of corporate structures when they should have been taxed under employment as any other employee. The rules only apply to "relevant engagements", that is, 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 the client.
What are the implications?
All the income earned is treated as employment income and therefore the tax advantage is lost. It was intended that IR35 legislation would ensure compliance with tax law so that, apart from specified deductions, all money received by the intermediary in respect of relevant engagements would subject the individual to Schedule E Income Tax and Class 1 National Insurance, thus all dividend payments and many business expenses were not allowed.
How do I determine if I am outside IR35 or Inside IR35?
To determine whether you are inside IR35 or outside IR35 there are three main tests to establish employment status, as follows:
- Control: a worker is not an employee unless there is a right to exercise control over the worker. This could be a right to control what work is done, where or when it is done or how it is done. The right of control is what is important and not the actual control.
- The right to get a substitute or assistant to do the job: personal service is an essential element of an employment contract. A self-employed person has the freedom to choose whether to do the job himself or hire someone else to do it for him or her; s/he may hire someone else to provide substantial help.
- Mutuality of obligation: there should be various mutual obligations within the contract. 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 consist of more than this, there needs to be obligation to offer, and an obligation to accept, future work.
There are also many other factors
- Financial risk: there must be real risk of financial loss. For example, an individual who risks his or her own money by investing in assets needed for the job and pays their own running costs and overheads is, most probably, self-employed. Financial risk could also take the form of working on a fixed-price for a job, for example, with the risk of bearing the additional costs if the job overruns. However, this will not necessarily mean that the worker is self-employed unless it is clear there is real risk of financial loss.
- Right of dismissal: in a service contract there is no right to terminate an engagement by giving notice of a specified length, which is a common feature of an employment contract. A service contract usually ends when the task is complete or if the terms of the contract are breached.
- Provision of equipment: all the equipment required for the job is generally provided by the self-employed contractor. The provision of significant equipment or materials that are fundamental to the engagement is of particular importance. For example, an IT consultant is engaged to undertake a specific project and works exclusively at home using his or her own computer equipment; this will be a strong indicator of self-employed status. But a worker who is provided with office space and computer equipment suggests employment, even if the worker occasionally uses his own computer at home.
- Basis of payment: independent contractors tend to be paid a fixed sum for a particular job. Employees, on the other hand, are paid a fixed wage or salary weekly or monthly and often qualify for additional payments such as overtime, a long-service bonus or profit share.
- Intention: the reality of the relationship 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.
- 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. People who are paid "by the job" will often be in this position.
- 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. For example, someone taken on to manage the client’s staff will normally be seen as part and parcel of the client’s organisation and is, therefore, likely to be seen as an employee.
- Length of engagement: long periods working for one client may be typical of employment, but will not stand up as conclusive evidence. It is still necessary to consider all the terms and conditions of each engagement. Regularly working for the same client may indicate that there is a single and continuing contract of employment.
- Employee benefits: employees are often entitled to sick pay, holiday pay, pensions and expenses. The absence of these benefits 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.
When the facts have been established, it is appropriate to look at the overall picture: whether it indicates a person operating under their own business or one working as an employee. If the evidence is evenly balanced the intention of the parties may then decide the issue.
Having looked at a number of standard agency contracts HMRC has, as expected, suggested that such contracts fail IR35. HMRC will consider only whether specific contracts fail the test and will not give any clearance on standard contracts.
The conclusion, bearing in mind all that is written above, is this: if you sign a standard agency contract you are likely to fail the IR35 Business Entity Test, even if you have the contract reworded. HMRC will look at the facts behind the contract. So be warned and beware.
Take a look now at theIR35 Checklist
AVOID THE IR35 TRAP WITH THE DNS SEVEN STEP STRATEGY
Since the Dragonfly case and the subsequent extended powers under the new Finance Act HMRC hold more of the cards in this game than ever. Many contractors still only focus on their contracts, but when working as a contractor, it is not enough to change only your label from employee to contractor, you must completely change the framework of your professional conduct – totally review your mindset. My advice to contractors is that you must think and behave like a contractor. Your contract alone cannot protect you because you can never be sure of your client’s reaction in the event of a problem. Even though your agency contract might define you as the "contractor", HMRC may still assert that you were acting like an employee, and this may then be corroborated by your client. This is exactly what happened in the Dragonfly case.
Please take note of our help sheet "Seven Ways to Avoid the IR35 Trap", guidance that I am sure will protect you in the event of an investigation, and which will give you a much stronger hand in the IR35 game.