Tax Legislation - IR35
The intermediaries legislation introduced in April 2000 relating to individuals supplying their services through their own companies has become known as “IR35”. It seeks to address the perceived abuse of the tax system whereby would-be employees set up and work under the guise of their own companies, which receive income outside of the PAYE tax system that would normally apply to payments made to employees.
IR35 seeks to tax all of the personal service company income as if it were the salary of the worker, but the liability to income tax and National Insurance Contributions is placed upon the personal service company, rather than the company’s client, i.e. the deemed employer. The company’s income from its clients is deemed to be a payment to the worker at the end of the relevant tax year, and is subject to PAYE.
Effectively IR35 is an extension of the PAYE system and HMRC enquiries normally begin as Employer Compliance Reviews (ECR). Under IR35 legislation HMRC investigate individuals to determine whether they are truly self-employed or a disguised employee of the business for which they are working.
The HMRC officer will normally inspect each of the personal service company’s contracts and seek to interview the worker about the nature of the working arrangements. The information obtained is then submitted to the local status inspector for his opinion as to whether IR35 should apply to the engagements concerned. The status inspector will often approach the company’s clients for information about the agreements between the relevant parties, including any agencies involved.
The legislation requires the status inspector to decide whether the contract forming part of the working arrangements represents deemed employment. Such decisions are made on the basis of numerous criteria established by many years of tax and employment case law.
The crucial thing therefore is to understand the difference between being employed and self-employed. The difficulty with this is that there is no legal definition to which one can refer.
Working Practices
Not only must your contract be IR35 compliant it must also accurately reflect your true working practices. It is worthless to have an IR35 friendly contract which does not accurately reflect what happens on a daily basis. It is your responsibility to ensure that this is the case. We always recommend that you confirm these details with the end client and, where possible, ask them to sign a working practices document, although this is not always practicable.
A self-employed person works under a ‘contract for services’ and an employee under a ‘contract of service’. It is, therefore, crucial to determine between the two types of contract. The difficulty with this is that there is no one legal test which the courts use in determining the type of contract in existence, to which one can refer.
Principal Factors
There are, however, a number of principal factors that have emerged from case law which need to be considered when operating as a Personal Service Company in order to remain IR35 compliant, especially when entering into a contract. These are:-
- Personal service - right of substitution
- Control
- Provision of equipment
- Financial risk
- Basis of payment
- Exclusive service
- Part and parcel of the organisation
- Right of dismissal
- Factors personal to the worker
- Mutuality of obligation
Personal Service - Right of Substitution
A self-employed contractor enters into a contract to provide a service rather than personal skills and should be able to provide a substitute, or engage helpers, to provide the service. An employee would provide his services personally. The case of Chaplin vs. Australian Mutual Provident held that:-
“… the power of unlimited delegation is almost conclusive against the contract being a contract of service.”
The right of substitution is one of the strongest tests of self-employment as shown in the cases of Echo and Express Publications vs. Tanton, Chaplin vs. Australian Mutual Provident and McMenamin vs. Diggles.
The right to substitute someone else to undertake the work must be a genuine one. You must genuinely have the permission of the client or agent to provide a substitute if the need ever arose.
The substitute must be answerable to, and paid by, the person who originally undertook to complete the contract, otherwise it could be determined that the substitute has in effect entered into a contract with the client or agent.
You must also ensure that the right to substitute is not unreasonably fettered - this means that if the client or agent places too many restrictions on the right of substitution the court may determine that the right did not really exist.
Control
The degree of control exercised by the employer over what, where, when and how the individual does the work is highly important.
A self-employed contractor may agree to perform a particular task at a specific time and place but it is unlikely that he or she will be subject to any right of control by the person who is requesting his or her services.
An employee, on the other hand, is likely to be told where and when the task should be undertaken. This is shown in the case of Morren vs. Swinton and Pendlebury Borough Council.
For control to be relevant, it must be much more than merely supervising or checking work. Unless a person is “tied hand and foot” to the contractor, then the necessary control is not present (Chaplin vs. Australian Mutual Provident).
Control over what the worker does will be clear, as he or she will be constantly advised by a manager or supervisor as to the work to be done. Where an engager can move the worker from job to job due to the changing priorities, then there will be a right of control over what is to be done and is a strong indicator of employment (Stagecraft Ltd vs. Minister of National Insurance).
Control over where the worker does the work may be in the contract. A contract of service will usually provide the client with the right to require a worker to work at a specific place. Where the tasks are to be undertaken at the client’s premises and the work is integrated into the daily routine, there is likely to be control. However it is important to note that the engagement may determine the location.
Control over when the worker does the work is obvious; an employee would be required to work set hours. A self-employed worker would be expected to arrange his or her hours to suit the task and his or her own convenience.
Control over how the tasks are completed can be difficult. In the case of Morren vs. Swinton and Pendlebury Borough Council, it was said:-
“Clearly superintendence and control cannot be the decisive test when one is dealing with a professional man or a man of some particular skill and experience. Instances of that have been given in the form of a master ship, an engine driver or a professional architect or, as in this case, a consulting engineer. In such cases, there can be no question of the employer telling him how to do the work, therefore the absence of control and direction in that sense can be of little, if any, use as a test.”
Provision of Equipment
Equipment and other facilities provided by the individual can be important. An employee will have all of the necessary major items of equipment and facilities provided by his or her employer. The self-employed will generally provide their own equipment (see Ready Mixed Concrete (South East) Ltd vs. The Ministry of Pensions and National Insurance).
The more essential the equipment is to the work, the more important this factor becomes, e.g. a milkman who does not own his own float will not normally be accepted as self-employed unless he leases or rents the float as part of a franchise agreement.
The HMRC will also take into account investments in skill, e.g. training.
Financial Risk
If the individual concerned is really in business on his or her own account this is the most relevant test of all. A self-employed individual is responsible for how his or her business is run. Unlike an employee, he or she will provide their own equipment, hire their own helpers, take a financial risk, take responsibility for investment and management and has the opportunity of profiting from sound management in the performance of his or her task.
The HMRC will look at the risk being taken by the worker, as it is not usual for an individual to be classed as self-employed if he or she takes no financial risk.
Basis of Payment
How an individual is paid will often be a factor as to whether he or she is employed or self-employed. Payment in terms of an hourly, weekly or monthly rate is associated with employment, whereas a self-employed individual will negotiate a rate for a job, invoice for the work done and bear his or her own expenses and overheads.
It should be remembered that the HMRC’s own Schedule E Manual states that a self-employed worker can be paid by the hour or day and therefore this test is inconclusive.
Exclusive Services
Where an individual works exclusively for one client, there is a presumption that he or she is an employee, as it is usual for a self-employed person to work for more than one person. HMRC do not see this as important however; their view seems to be that most employees are not restricted to working for one employer.
It has been stated in a previous tax bulletin that HMRC do concede that ‘long periods working for one company may be typical of an employee, but are not conclusive’. The article then goes on to say however that ‘regular working for the same company may indicate that there is a single and continuing contract of employment (Nethermore (St Neots) Ltd vs. Gardiner)’.
Part and Parcel
Many self-employed contractors often do not realise that they are gradually becoming part and parcel of the end user’s organisation and this usually happens in cases where a contractor has been providing services to the same end user for a lengthy period of time.
Pointers towards becoming part and parcel of the client’s business are:-
- Managing the client’s staff or being managed by a member of the client’s staff.
- Attending ‘staff’ meetings which do not relate to the services you are providing.
- Having to notify the client of absence within a certain amount of time e.g. within the first hour of the first day of absence.
- Attending company social events such as the Christmas party without paying etc.
- Receiving bonus payments relating to your performance.
- Access to free or subsidised meals from the canteen.
- Use of the staff gym.
You should be aware of these characteristics and ensure that you steer away from them. It is very tempting to accept the offer of a bonus payment however this could be detrimental when determining your IR35 status. You can, of course, include performance incentives providing they directly relate to the contractual terms.
Right of Dismissal
An employee would have the right to be given statutory notice of the termination of his or her employment whereas a self-employed person can have their contract terminated at short notice - sometimes even as little as one hour’s notice can be given.
Factors Personal to the Worker
Other factors such as VAT registration, professional indemnity, employers and public liability insurances, health and safety requirements, licences and advertising etc. should be taken into account.
Mutuality of Obligation
An employer will try to make sure that their employees have a continuous supply of work and will also expect the employees to carry out the work when it is required. A self-employed person will do the work he or she has been contracted to do and will complete the project with no expectation of further work.
When work is regularly provided and accepted over a period of time, the HMRC may take the view that ‘employee’ status has been created by custom and habit. A long notice period (say exceeding 30 days) is an example of this.
The above information is provided as guidance only. Freelance World provide a contract review service to ensure your contracts are IR35 compliant. This can be underpinned by a range of IR35 insurances to ensure complete peace of mind For more information please visit the QDOS website.
What happens if I am caught by IR35?
You will be liable to pay tax and national insurance on all of the companies profit. The HMRC may also impose penalties, fines and add interest to any amounts due.
Another negative is that although HMRC regard your relationship with the client as that of an employer and employee it does not actually create such a relationship i.e. you do not get any employee benefits such as holiday pay, sick pay etc.