Reclassifying employees as contractors

Reclassifying employees as contractors

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My client wants to reclassify 5 of their employees to independent Ltd Co subcontractors. IR35 issues aside, I can imagine that HMRC would attack this situation from the employer perspective.

Does anyone have any info on how HMRC would attack this and any angle of approach?

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By frustratedwithhmrc
14th May 2011 09:21

IR35 is just a means to an end.

HMRC and it's predecessors have been dealing with the problem of 'false employment' since PAYE and National Insurance first created tax advantages to being Self Employed versus PAYE. IR35 is just the latest (albeit poorly implemented) battle in this ongoing war.

Strictly these are matters of employment status, but by definition, if the employment status of a worker is that they are 'Self Employed', then the company for which they have a 'contract for services' is not responsible for their taxation, it is the worker themselves. Equally, if a worker is determined as being under a 'contract of service', then the company is responsible for their taxation.

If the company was wanting to expand its sales division and decided to put these out for contract on a commission only basis (i.e. "Contract for Services"), then provided they were picked up by 5 limited company contractors acting on a self employed basis and the correct guidance was taken to ensure self-employment (Intention of the Parties, Control, Mutuality, Badges of Trade, Substitution, Ability to profit from sound management, Exclusivity/Sole Customer, etc.), then the company would be unlikely to be challenged on the basis of existing case law (e.g. Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance [1968]), although the 5 individuals themselves could be attacked under IR35.

However, in your circumstance, the company is effectively deciding that 5 of its existing employees will go from being 'employed' to 'self employed'. While there may be a very good business reason for needing to take this approach (and the reduction in Employers NI isn't one), it would certainly be subject to an enquiry by HMRC if they became aware of this miraculous transformation.

In this case, I would expect HMRC to undertake an "Employment Status enquiry", considering the following aspects:

http://www.hmrc.gov.uk/manuals/esmmanual/esm0558.htm

If these workers were determined as being employed rather than self-employed, then HMRC would be able to assess the company for unpaid PAYE, Employees NI, Employers NI + penalties (up to 100% of tax evaded) + interest. On top of the tax investigation costs, this can soon mount up. The basis for this being that the company had deliberately evaded PAYE and National Insurance.

Equally, HMRC could also go to the 'employees' and subject them to enquiries under IR35. There is nothing to stop them doing this, even though the net effect might be that they get paid the same tax twice. I doubt that the 5-workers would really appreciate having to shell out tens of thousands of pounds in unpaid tax, penalties and interest just so the company could engage in a bit of tax evasion.

Given all of the above, would you still advise your client to do this? I certainly wouldn't.

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By zebaa
14th May 2011 10:23

Good answer frustratedwithHMRC

Good level of intersting detail and a excelent conclusion. A model answer, in my view.

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By fellowcraft
16th May 2011 14:13

Is that correct though?

My understanding is that HMRC cannot levy the unpaid PAYE/NIC against the company unless the subcontractors are self employed, hence the new Limited Companies.

In that situation, I reckon they'd leave the company alone and go down the IR35 route.

Please can someone confirm whether my understanding is correct.

 

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By frustratedwithhmrc
16th May 2011 15:05

Hard to prove that the Company wasn't complicit though.

In theory, yes. The company could argue that this was done in a completely independent manner and is totally above board, therefore they should no longer be accountable for their former employees PAYE and NI even though they still work for the company, albeit under a self employed contract rather than an employee contract.

The problem is that HMRC are a suspicious lot and if they find something going on that smells like tax evasion then they are going to investigate - even if just to confirm that everything is above board. That is after all part of their job.

However, since the amount the company pays in Employees NI and Employers NI will be reduced for these 5 employees (although you might pay them the same money overall), this looks indicative of evasion even if it isn't in reality.

HMRC have a nasty habit of going after whichever party they deem has got the deepest pockets and that's usually the company. They might even steamroll one or more of the 5-newly created "self employed" LTD company contractors into saying that the company coerced them into it (so they get reduced penalties for cooperation).

I am not saying that HMRC would fabricate evidence, far from it. They do however have extensive powers and are specially trained to deal with face-to-face interviews during investigations, which can become quite gruelling.

I'm not arguing the merits or otherwise of HMRC's position, however you have to at least accept that they are entitled to view it that way and attempt to prove what they believe to be true, namely tax evasion on the part of the company.

Even with the best intentions and the best documentation, it is hard (but not impossible) to prove a negative.

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