A GUIDE TO IR35, by Ralph Elliott-King
The new regulations were introduced on 6th April 2000 and will be of relevance to anyone who offers their personal services from that date (as the 'worker') to a client that is then invoiced through the worker's own limited company or small partnership (the 'intermediary'), and the nature of the engagement is similar to a situation in which the worker behaves to all intents and purposes as an 'employee' of the client.
Many clients need to take on specialist consultants for relatively short contracts, and in order to avoid any potential PAYE/NI tax problem themselves they insist that these people should be a member or employee of an intermediary. The client then contracts directly with the intermediary. The arrangement seemed to suit everyone until the Inland Revenue became aware that many of these consultants with intermediary companies were enjoying a significant tax advantage because they were taking their earnings out of their company by way of dividend that did not attract National Insurance.
IR35 was introduced to stop this practice. Those individuals affected by IR35 may find that this year they pay more National Insurance on their earnings. They may also find that they are required to pay tax on the 19th April that in earlier years would have become due as corporation tax or income tax that would be payable several months later. For this reason anyone affected by IR35 should spend a little time planning what is going to happen next April if they are going to avoid a cash flow problem next year.
The first step you need to take is to work through the following flow chart to see if IR35 applies to any of your engagements since 6th April 2000. The flow chart is neither conclusive nor exhaustive, but if you feel there is any possibility that the new IR35 rules may affect you then seek advice from your accountant sooner rather than later. The clock is already ticking down to the 5th April.
If IR35 does apply to you then you need to take some precautions between now and 5th April 2001
Before the 31st December 2000
It is part of the process of deciding whether IR35 applies to a particular situation to take a look at the 'employment status' of the worker involved. The status of a worker can either be 'self-employed' or 'employed' and is decided by considering the nature of the overall working relationship between the worker and the client. It is relevant to IR35 because the new regulations will only apply to situations where the worker would be deemed to be an employee of the client, were it not for the presence of the intermediary.
There is no statutory definition of what constitutes employment, so status is determined by reference to a series of standard 'indicators of employment' that have arisen from case law. The Inland Revenue has published several documents and guides that explain its view on how employment status should be determined. They can be obtained from your local tax office or downloaded from their website.
A few of the indicators are listed below. Their application to a particular situation is very subjective, and where there is the opportunity for a difference of opinion to arise, there is also the certainty there will be confusion. One should exercise caution in deciding which of the indicators apply to your engagement, and be prudent in their interpretation.
Taxpayers tend to be over-optimistic when judging employment status and unrealistically biased towards self-employment for obvious reasons. No one likes paying taxes. You should be objective when you look at your employment status and if you have any doubts then seek the opinion of your accountant. You also have the option of applying to the Inland Revenue for a final decision on the employment status of a worker in a particular engagement, and its opinion, after all is said and done, is the only one that matters.
Factors that should be considered when deciding the worker's employment status
Right of control: If the client has more control than the worker over what work is done, where and how it is to be performed, and when it is to be carried out, then the status will be one of employment. If a worker can come and go as they please, and decide how, when and where the agreed work to be undertaken is carried out, then status leans towards self-employment.
The right to substitution or appoint helpers: It is a normal characteristic of self-employment that the worker, at his or her own cost, has the right to arrange a substitute to take their place, or to appoint further helpers to get the work done. These options are not normally available to employees. The Inland Revenue has indicated that where a worker has a contractual right to arrange a substitute or helper, but has first to seek the permission of the client to do so, then this will be a clear indication of employed status.
Provision of equipment: It is a normal characteristic of employment for the worker to be provided with equipment, desk and office space, PCs etc from the client. It is indicative of self-employment when an individual works from their own office (including home) and uses their own personal equipment and tools. It is interesting to note that the Inland Revenue has pointed out that a worker who chooses to use his or her own equipment in preference to that supplied by a client will still be viewed as employed.
Basis of payment and financial risk: If the worker is remunerated at a contract rate (by the hour/day, etc.) and is not at risk of making a loss on the outcome of the engagement then this kind of arrangement suggests employment. A self-employed person is more likely to arrange a fixed contract price for completion of a job and is in a position to profit from better management of the task in hand.
Part and parcel of the organisation: The more integrated the worker becomes in the management structure of the client, the more likely it is that he or she will be viewed as employed.
Length of engagement: There are no set rules, but the longer a worker stays in a contract with the same client the more likely that the role assumes one of employment.
Agency workers: The Inland Revenue has indicated that where there is an engagement involving the intermediary contracting with an employment agency to place a worker with a client using a typical 'standard agency contract' and the arrangement lasts for more than one month, the engagement is to be viewed as employment. This kind of arrangement is favoured by most of the professional contracting agencies that cover the medical, IT and consultancy market sectors. Please note that engagements of less than one month will be judged on a case-by-case basis using the standard indicators of employment status.
Intentions of the Party: It is always good business practice to have a written contract in place, and in the event that all other indicators of employment status are evenly balanced then the intentions of the contracting parties will decide the case. Many authorities have expressed concern over the proliferation of standard contracts marketed as 'IR35-proof'. If you intend to use such contracts then you must ensure that the terms expressed in the contract reflect the actual reality of the working arrangement. The Revenue has the right of considering substance over legal form and many tax payers have come to grief in the past because they tried to rely upon 'contrived' contracts that failed to stand up to scrutiny.
Further reading:
IR Business Series Booklet IR175 "Supplying Services through a limited company or partnership" The Revenue's own booklet written for taxpayers.
IR Business Series Booklet IR490 "Employee Travel. A guide for tax and NICs for Employers" Useful reminder of revised Schedule E rules on allowable travel and subsistence expenses.
Tax Bulletin Issue No.45 February 2000 - A useful outline of the factors the Revenue has highlighted from case law on the 'indicators of employment/self employment' with several examples.
What does IR35 mean to me if I do fall within the scope of the new regulations?
If you have any relevant IR35 income in the year ending 5th April 2001 then you may find that a further charge to tax may fall due for payment in April. The way the new IR35 tax is calculated is not straightforward and your accountant will be able to give you a much clearer indication of the amount involved. As the final tax bill could be zero or measured in thousands of pounds, it is essential for you to review your situation so that you gain an approximate idea of the sums involved. The following quick calculator will do just that. Enter your figures to date since the 6th April 2001 in the left-hand column. The example figures on the right are given purely as a guide to show you how the calculation works.
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Example |
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ROUGH GUIDE IR35 TAX CALCULATOR: |
£ |
£ |
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Base period: Only include items received or paid for between 05.04.00 and 06.04.01) |
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Enter the gross income from IR35 relevant contracts |
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60,000 |
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Add: Any benefits paid or received by your business from clients |
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500 |
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________ |
________ |
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Subtotal: |
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60,500 |
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Deduct: 5% of "Subtotal" |
. |
(3,025) |
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Deduct: The gross salary paid to you by your business |
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together with the associated Employers' NI |
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(22,440) |
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Normal travel and overnight expenses |
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(relevant engagements only) |
. |
(5,345) |
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Pension contributions paid by the business on your behalf |
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(6,000) |
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________ |
________ |
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Net Result (see Note 1) |
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(23,690) |
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Calculate the National Insurance due 19th April 2001 |
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by multiplying the 'Net Result' by 12.2/112.2 |
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(2,576) |
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________ |
________ |
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The Deemed Payment |
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21,114 |
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________ |
________ |
Note 1:
If the indicated subtotal we refer to as 'Net Result' (£23,690 in our calculation) is a minus number or equal to zero then no further charges to National Insurance and Schedule E tax arises.
If the amount is positive you must first calculate the National Insurance charge by multiplying the 'Net Result' by 12.2/112.2 and then deduct this figure from the 'Net Result' to arrive at the Deemed Payment.
The final Schedule E tax you will pay will be calculated by adding the Deemed Payment to your total salaried earnings from the Intermediary for the year ending 5th April 2001 by applying the normal payroll taxation rules.
In the example given, assuming that no other salaried earnings were involved and the worker had a tax code of 438L, then the additional PAYE that would fall due for settlement on the deemed payment of £21,114 would be as follows:
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£ |
£ |
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National Insurance (Employer's element at 12.2% as above) |
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2,576 |
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PAYE (extracted from payroll calculation not given here) |
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6,583 |
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Employee's National Insurance (extracted from payroll calculation not given here) |
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538 |
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________ |
________ |
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Total tax payable on 19th April 2001 |
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9,697 |
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________ |
________ |
People are often surprised at the size of the final tax bill in the given example. It must be emphasised that when you work out your IR35 tax position, it may be that no further charges to tax exist at all. It will depend upon the amount of your relevant earnings after making a 5% reduction, the amount you pay yourself as salary, and the amount of relevant expenditure you are able to offset against the income.
The example given is, however, fairly typical of many consultants who in the past would have paid themselves a very low monthly salary and taken the profits out of their company via dividends that would not be subject to National Insurance. It was to counter this practice that the IR35 regulations were introduced in the first place.
If the worker takes a low monthly salary (as in the example - £22,440/12 = £1,870) from the intermediary relative to the monthly relevant earnings (£5,000) they are personally generating, then a charge to additional IR35 tax is likely to arise. In contrast, if the worker above received a monthly salary of £3,845 (£23,690/12 +£1,870) then the calculated deemed payment in the example would fall away to just below zero and no further charge to IR35 tax would arise.
The higher salary does not of course reduce the overall amount of tax payable by the 19th April 2000. It merely spreads the charge over the year as the tax is collected on the higher monthly salary as part of the normal payroll operation.
The Judicial Review of IR35: News for users affected by the IR35 Regulations
In the High Court on the 10th October 2000, The Professional Contractors Group (PCG) won a Judicial Review of the IR35 Regulations.
Both parties agreed to submit evidence to the review by 12 January 2001. A hearing will then take place on 5 February, which is likely to take two to three days at least for all the evidence to be presented.
It will be a brave person that ignores the affect of IR35 on their own situation in the hope that next February's Judicial Review will result in the repeal of the new regulations.
Whatever your views on the matter, the IR35 regulations continue to apply for the moment and you should therefore take it into account when reviewing your tax planning options over the next six months.
You should continue to monitor the level of IR35-relevant earnings since April 2000 and the IR35 tax liability that may or may not crystallise next April depending upon the level of salary and expenditure you can set off against those earnings.
As the typical earnings of a consultant falling within the scope of IR35 can often result in an IR35 charge to tax of several thousands of pounds to be paid next April you can see why it is important to stay on top of the matter.
It might be prudent to discuss the matter with your accountant and leave any final tax planning for IR35 until we learn of the outcome of the Judicial Review. It will still remain essential for you to gather the information needed to make the required decisions and make some contingency plans in the event that the Inland Revenue does win the day next February.
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