IR35 brought back to basics

IR35 has been the bane of many of a contractor since it was introduced back in April 2000. Recently the controversial legislation has been garnering much media attention after the coalition government promised to review it as part of their plans to simplify the tax system for businesses. So now’s a good time to ask: what exactly is IR35?

Why does IR35 exist?

IR35 was created at the beginning of the new millennium to stop the scenario whereby someone could take advantage of the tax breaks of an independent contractor despite, in practice, remaining an employee.

There was the theoretical possibility that an employee working for an IT firm (for example) could go home one Friday as an employee and come back the following Monday as a contractor. His working practices may have remained the same, but his tax status would have changed for his benefit. The government decided this was a loophole that needed to be closed.

Enter IR35 with the task of ceasing the practice of employees effectively disguising themselves as contractors. Hence, the description of IR35 as ‘disguised employment’ legislation.

HMRC describes the objective of IR35 as follows:

“The aim of the legislation is to eliminate the avoidance of tax and National Insurance Contributions (NICs) through the use of intermediaries, such as Personal Service Companies or partnerships, in circumstances where an individual worker would otherwise

For tax purposes, be regarded as an employee of the client; and

For NICs purposes, be regarded as employed in employed earner’s employment by the client.”

In summary, you must ensure that your company doesn’t simply exist to provide a tax-efficient self-payment service.

The problem with the legislation is that it provides a serious cause for concern for legitimate contractors. From April 2000, the UK’s contractor workforce has had to be wary of falling foul of the legislation.

IR35 was so controversial at its inception that PCG – the Professional Contractors Group – was established in response to it: the founders of the trade body felt that their own entrepreneurial ambitions would have been seriously undermined if the legislation had been in place back when they first started out in business.

A brief breakdown of how IR35 comes into action

If you provide your services to a client via your own ‘service company’ then IR35 may come into play. HMRC often refers to ‘service companies’ or ‘personal service companies.’ This simply refers to the fact that you’re a company that sells a service and not a product, via your own limited company.

The onus is on you to prove that you are not abusing the system!

How to prove you are not a ‘glorified employee’

Despite the complexity of the legislation, there are a number of ways in which you can prove your credentials as an independent contractor.

HMRC lays down a number of questions to help you work out whether you are a ‘disguised employee’ or a ‘bonafide contractor’:

• Do you work set hours, or a given number of hours a week or a month?
• Do you have to do the work yourself rather than hire someone else to do the work for you?
• Can someone tell you at any time what to do, when to work or how to do the work?
• Are you paid by the hour, week or month?
• Can you get overtime pay?
• Do you work at the premises of the person you work for, or at a place or places he or she decides?
• Do you generally work for one client at a time, rather than having a number of contracts?

If you answered YES to most of these then you are most likely an employee.

Still not sure? Try answering this set of questions courtesy of HMRC:

• Do you have the final say in how you do the work for the client?
• Can you make a loss on the contract?
• Do you have to provide the main items of equipment you need to do the job for the client, not just the small tools many employees provide for themselves?
• Are you free to hire other people on your own terms to do the work you have taken on?
• If you are free to hire other people on your own terms, do you pay them out of your own pocket?
• Do you have to correct unsatisfactory work in your own time and at your own expense?
• Do you have a number of clients at the same time?

If you managed to answer YES to most of these then you’re probably okay. However, it’s important that you judge each of your contracts on a case-by-case basis.

The penalty for falling foul of IR35

If you’re deemed to be non-IR35 compliant, then HMRC will look to recoup the tax you’ve avoided paying in the past, along with any interest and/or penalties which may be charged if any additional tax/NICs are due as a result of any review or enquiry.

The future of IR35

The coalition government recently established the Office of Tax Simplification in order to make the tax system less complex. One of the big tasks of this new office is to take a long hard look at IR35 and seek to replace it with simpler measures. But, as one commentator said: the Office of Tax Simplification has a far from simple job.

The findings of their review will be published in time for next year’s budget, so time certainly seems to be ticking for IR35; the question is: how are they going to replace it without reopening a potential tax loophole or simply substituting one piece of complex legislation with another?

The HMRC website has some useful, though sometimes jargonised, advice.

Image by Esko Kurvinen ~ cc

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