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An IR35 refresher By Nichola Ross Martin
What is IR35?A special set of rules found in s 48 to 61 of ITEPA 2003 in which the income of certain companies or partnerships is taxed as if it were the deemed employment income of the company owner or business partner.
When does IR35 apply?
It applies when:
- an individual personally performs services for a client, and
- the contract to supply those services is made between the individual's own limited company, or partnership, and ultimately the end client, and
- the circumstances of the arrangement are such that, if the individual had contracted directly with the client, he would be regarded as an employee of that client.
In other words, it applies when what might normally be expected to be the employment income of an individual is passed through a company or partnership – 'disguised' employment income.
The reason that income may be passed through a company or partnership is irrelevant, as is the motivation behind trading in this way. At one end of the spectrum the arrangement might be for tax avoidance, but at the other it might be because the end client will only contract with companies, and will not take on individuals directly.
What sort of companies and partnerships are affected?
IR35 applies to companies if:
- The worker (or his family) controls more than 5% of the ordinary share capital of the company, or
- The worker (or his family) is entitled to receive more than 5% of any dividends from the company, or
- The worker receives, or could receive, payments or benefits from the company which are not salary, but could reasonably be taken to represent payment for the services provided to clients
IR35 applies to partnerships if:
- The worker (or his family) is entitled to 60% or more of the partnership's profits, or
- where most of the partnership profits come from work for a single client, or
- where a partner's share of profits is based on his income from relevant contracts
A 'family' includes blood relatives and civil partners.
Employment status
If it is not obvious, it is necessary to review the contract and the facts of the case to see what factors are relevant in determining whether the contract is one of service or for services. Employment status is not such an easy matter to determine in practice, which is why IR35 is time consuming for HMRC to try and enforce. Contractors must self-assess their employment status for the purpose of their tax returns, and if HMRC does not agree, then status will be determined by a tribunal or the courts.
General reading
HMRC publish a leaflet, IR175 'Supplying services through a limited company or partnership: A general guide' This gives full links to employment status checks. This appears on AccountingWEB.co.uk's IR35 links pages.
Managed service company rules
The MSC rules were brought in to counteract schemes to avoid IR35, whereby workers supplied their services via MSCs. Following legislation introduced on 6 April 2007, income from MSCs is treated as deemed employment income.
IR35 worked example
Bill is an IT consultant, and he and his wife Mrs B have set up their own limited company "Our Co Ltd". They own 50% of the shares of the company each. Bill provides IT programming services to End Client under a three year contract. Mrs B does the company bookkeeping, but does no work for End Client.
End Client pays £65,000 to Our Co Ltd for the services provided by Bill in 2007/08. All these services are performed at End Client's premises.
Bill pays himself a salary of £20,000 and pays Mrs B £5,000 during the year under PAYE. Our Co Ltd reimburses Bill for his travel expenses from home to End Client, which comes to £2,500, subsistence of £500, a subscription to IT weekly magazine of £65 for the year. It also pays Bill and Mrs B rent of £500 per month for use of home as office. Our Co Ltd also pays £3,000 into Bill's stakeholder pension scheme and £500 into his wife's.
Just before the end of the tax year, Bill, on taking professional advice about dividends, discovers that he would not pass any of HMRC's employment status tests! IR35 applies to his contract with End Client. He must therefore self assess and account for a deemed payment under the provisions as if it were paid on 5 April 2008. He has to account to HMRC for PAYE and NI by 19 April 2008, and the deemed payment will be included on his P60 and Our Co Ltd's P35.
IR35 deemed payment calculation:
£ | notes | ||
| Fees received by Our Co Ltd from client | 65,000 | ||
| Less: | 5% of fees (£65,000) | 3,250 | 1. |
| Pension contributions | 3,000 | 2. | |
| Salary | 20,000 | 3. | |
| ERs NIC on salary | 1,895 | ||
| Excess | £36,855 | ||
| Deemed employment payment: | £36,855 x 100/112.8 | 32,672 | |
| Ers NIC: | £32,672 x 12.8% | 4,182 | |
| £36,855 | |||
Notes
1. The 5% deduction covers the expenses of Our Co Ltd, but there is no deduction for any of Bill's expenses, as his travel and subsistence would not be allowed if he worked directly for End Client (his travel is disallowed as he cannot claim that he works from home as his home is not where any of his employment duties are performed). His magazine subscription is actually taxable benefit in kind (reading magazines is not in performance of being an IT programmer), so Bill could have accounted for this on his P11D as a benefit and been taxed on it. It would then have been deducted the amount from the deemed payment calculation. His accountant suggested that he takes the administratively easier option of just not deducting it from his deemed payment. None of the expense payments to Bill's wife's are deductible in the deemed payment calculation - the 5% covers bookkeeping and overheads such as phones.
2. Only Bill's pension contribution is deductible, (see 1 above).
3. Only Bill's salary and the employers NI thereon are deductible.
Further reading on IR35
AccountingWEB.co.uk's IR35 links pages.
Number of comments: 31
AccountingWEB.co.uk 9-Jun-2008
Categories: Tax Features, Tax - Nicki Ross Martin
Times read: 12119
@Mike Whittaker
"But I can't see any law-making body having an interest , or even being able to understand the point in rectifying the fallout."
Exactly. This is why I believe the contracting community at large, and its representative bodies should use all legal avenues to discredit IR35. There definitely should be some employment implications from being found caught by IR35.
@JW
At the very least, the finding of a contract to be within IR35 should cause an automatic opt-in to the Agencies legislation, to give increased protection to the worker as a nod towards the "deemed employment".
But I can't see any law-making body having an interest , or even being able to understand the point in rectifying the fallout.
"Remember the company is required by the end user of their services so that they don't have to operate PAYE and give employment rights etc."
exactly the point I made to Mr. Justice Elias in my EAT, but was severely rebuked by him for claiming so!
What I believe is very sad is that all and sundry are still chewing the fat over IR35, and many are making a nice little earner from doing so, but no one is prepared to make a concerted effort to make it difficult for the Government to maintain its stance of taxing individuals as employees whilst denying those individuals employment rights.
Dawn Primarolo claimed in a letter to me personally, that it's the contractor's own company that must provide the employment rights, whilst HMRC denies the company the ability to provide those benefits from pre tax profits just like any other company is allowed to do.
No one seems to be interested in using this angle, perhaps via the EU courts. Additionally, there is the issue of the EU directive which states something along the lines of VAT cannot be levied on employment or any other engagement which "looks" like employment.
I know the legal eagles have said these issues are not worth pursuing, but I have proven eminent barristers can be wrong in their opinions. Let's not take notice of any opinion other than a court ruling. I've beaten two large corporations in court, by presenting the issues for a judge to rule on. Actually both conceded defeat before a court appearance was necessary.
The message is don't give up before you've tried. We have Constantine to thank for Christianity in the Western World becuse he didn't give in to his enemies in battle before engaging them despite his forces being overwhelmingly outnumbered.
Every legal avenue to neuter IR35 should be explored, whatever the result. At least then there would be improved clarity, but alas there are those who do not want clarity, in order to perpetuate the uncertainty that IR35 brings, so that income streams can be maintained. Sorry for being so cynical!
It's about time that the fat chewing stopped and a concerted effort is made to effectively neuter IR35.
I absolutely agree Mike.
People now caught by IR35 (most of the ones I deal with are Engineers) are paying more tax, whereas before IR35 they paid less.
People who can demonstrate that they are self employed without the intervention of a company are still paying less.
So doubly unfair on contractors. More tax and the inconvenience of a company. Remember the company is required by the end user of their services so that they don't have to operate PAYE and give employment rights etc.
The point is that people will generally arrange their affairs to acheive the lowest tax rate possible.
The unfairness arises from the targetting of one group of workers to stop them from doing this.
This is far more extensive than just IT consultants and other contractors. It includes the non incorporated self employed and employees.
Since IR35 relates to the engagement with the client, and it's possible that
a) a company may have more than one client at a time
b) a company may have previous and/or subsequent engagements not caught by IR35
does this mean that a) whether it's a BIK depends on whose work he's thinking about as he reads the trade magazine and b) whether it's a BIK depends on whether he's in the middle of an IR35 job, and it ceases to be a BIK as soon as he stops work for that client, conversely starts to be a BIK when he starts work for an IR35 job.
What about an IR35 investigation/case that changes the status - all the BIKs potentially get flipped over ?
Looks like the best thing to do is pay for all potentially-BIK expenses (including any training, which is also non-exempt according to HMRC - who laughably state that "Employees cannot generally get tax relief for money they spend on their own training": no, the employer pays the cost of the training at its own expense !!) while not in an IR35 contract.
PS. Although if the training takes him away from the client's site for a few days, what's to stop him stating that the training is nothing to do with the client and hence purely for the company, and hence not part of the deemed employment, hence allowable as an expense...
Sorry to be slow to respond. Outside IR35, if the employer buys the mags, or reimburses the employee for the mags it wants, there is no benefit in kind - providing the mags satisfy s 34 ITTOIA and are allowable for the employer's business.
If the employee buys the mag, and then tries to get tax relief from HMRC he makes a claim under s 336 ITEPA, unfortunately the courts are very strict on this, so unless it is your job to buy and read mags, no deduction.
With the IR35 deemed payment, an expense is only allowable if it is part of the deemed employment or incurred on behalf of the employer. So, taking the end client as the deemed employer, it did not reimburse the deemed employee for the expense, and the deemed employee would not get a deduction under s 336, so no deduction in deemed payment.
Mags and BIKs: providing the mags are related to the employer's business, or for kitting out its reception etc. It can buy what it wants and let any employee read them without a BIK.
So - trade magazines are a BIK.
How does that work out if there's more than one worker ?
This is exactly the point I've been making for years. Anyone caught by IR35 will pay more tax than any other organisation or individual would on the same level of income and will not in reality receive any benefits of those organisations or that employed individuals would receive. So how on Earth can anyone in Government say that IR35 is fair?
Unfortunately there are those individuals who have been persuaded to pay the tax and have been intimidated by the whole environment such that they don't challenge the advice. I have a collegue who sits next to me, doing the same tasks as I do and he pays his IR35 taxes, but I don't. Only a court of law can decide an individual's employment status, as was mine, and clearly not all courts agree. So how can any advice regarding IR35 be regarded as accurate?
Not all of the "establishment" are able to make laws, but in essence, generally they are not expected to "rock the boat". As far as I can see, those organisations representing for example, architects, solicitors and accountants, have a code of conduct which precludes any disruptive protests against Government and the "state". Clearly in relation to disturbing the equilibrium of everday life, these groups potentially have more power than most industrial groups. However, much like the police, as a reward for "toeing the line", there are special considerations for these groups, not the least a level of respect in society and membership of the Freemasons, dare I say.
It might interest you to know that my grandfather, a miner, was a communist and my father, who was a bricklayer, was perhaps 0.001 of an inch right of communism. Bearing in mind they were and I am Welsh, and have been subject to the exploitation of the English ruling classes (we have a word in Welsh for them), it's not surprising that I'm sceptical and suspicious of the "establishment". However, there are many, and I might be persuaded, who believe that Labour Governments are really only the pawns of the ruling classes and are engineered into power to install unpopular laws, which the working class grudgingly accept, because "it's our party in power".
I assume you went to university or college and have always worked in a "professional" environment. So I doubt that you've had the exposure to radical attitudes that I've had. I worked in the steel industry for many years and became a union representative. So perhaps you can begin to understand a little why I hold the opinions I do.
However, providing I do not deliberately insult individuals on this website, I am as entitled as anyone else to express my opinion, which incidentally I do not believe is paranoid given my personal experiences in life and having knowledge of the experiences of others who have come up against "the establishment" Remember, Winston Churchill, great man that he was, would never set foot in the Rhondda valley. Such emnity does not exist in England. Are they all paranoid in the Rhondda?
@Neil
However, if you look at the effective rate of tax (=tax+NIC) on an IR35-liable worker, you will see that it is much greater than a 'standard' employee, or than that on a self-employed worker, as a fraction of the sum available to be paid as "drawings" of some kind, due to both NICs being levied simultaneously from the available 'pot'.
Hence IR35 errs on the other side by being unduly penalising.
John
I'm glad you are not trying to win support.
I note "the Man" is out to get IT consutlants and no one else, so the HR and other consultants I deal with have nothing to fear from the conspiracy. That is quite a relief for them, I can now tell them that HMRC must have mistaken them for IT consultants.
And silly me, I thought that most of the targetting was on IT consultants because they were the largest group using service companies.
I think everyone needs healthy cynicism but paranoia needs treatment.
I note your opinions and observations. I also note the establishment includes greivous accountants, misrepresentling barristers and any organisation whose opinion does not fit your view. Those same members of the establishment have, according to your thrid paragraph now legislate against themselves. Hmmm a bit of a contradiction there
Still come the revolution, I am sure you know who will be first against the wall.
It is simply tiresome talking to conspiracy theorists particularly when observation and rumour are presented as facts and correlation as cause and effect. Perhaps Halliburton encouraged the Chancellor to introduce IR35 because the IT consultants were going to to blow the gaffe about the company flying its corporate jets into buildings in the US because it had used IT consultants to create the flight numbers and passenger manifests and IR35 would keep them distracted for a long time. Therefore, I am not going to play the game.
I'm not trying to win support for my cause. As far as my case against HP is concerned, that is history. I just used that example to illustrate that you cannot trust members of the "establishment" to have your interests at heart. I could give you personal examples where I've been lied to by the police, where a barrister misrepresented facts in court, where employees of an organisation also misrepresented information, where politicians have lied to me and finally where an accountant caused me grief. So there is no "computer" chip on my shoulder. When any arm of the "establishment" disadvantages me, then I will say my piece.
Let me make some observations and then you try to contradict my opinion. When IR35 was introduced, the only people who tried to challenge it were the IT contractors who eventually formed the PCG (including myself). There was little or no political opposition from anyone else (I class the judicial review as political) to the regulations. Could this be because those that were closely involved, i.e.solicitors and accountants could see a good income stream from dealing with the issues? you decide. Because the regulations were clearly targetted at the IT community, with little or no collateral damage to anyone else, then other groups were dis-interested.
Now we have the "family business tax" or "income splitting" as HMRC prefer to call it. I remind you that these regulations have been proposed as a result of HMRC losing a case against an IT consultant. However, This time there could be far more collateral damage and other groups, including partnerships, which could include accountants and solicitors, are now lobbying HMG to abandon these proposals. Funny how these groups were and are not interested in lobbying for IR35 to change. Note also that our eminent poster Ms. Nichola Ross Martin continues to provide examples of IR35 application and "income splitting" related to IT consultants and makes no mention of any other group. Perhaps then you can understand why I'm a little cynical about the motives of the accounting profession. So I would hardly call healthy cynicism and distrust of the "establishment" a "computer" chip on my shoulder.
So I don't have a "chip" on my shoulder, I'm just highlighting that only when vested interests of the peripheral members of the "establishment" are at stake, do when get any interest in stopping HMRC plans.
Minimum wage doesn't apply to company directors and most self employed people will be directors of their own companies.
They can then pay themselves to the lower earnings limit and take the rest as dividends.
So there is no personal tax or NIC until they have income into the higher rate tax band.
So tax at corporation tax rates only for standard rate tax payers.
@Neil:
But why only look at NIC - employed/self employed pay no CT ... but those working through their own company probably pay at least the minimum wage, which will attract Class 1 (more so now 10% has gone) and both types of NIC.
[PS] I would imagine all respectable accountants would advise against taking all drawings as divi :- HMRC would clearly perceive this as " 'avin a larf" - and asking for trouble.
Thanks Mike.
I do appreciate the points you made.
These are all reasons why employees tend to get paid less than self employed people. They are not reasons why two people on the same income can pay different amounts of tax and national insurance.
I don't know why the establishment feels employees should have employers paying 12.8% of their earnings and pay 11% of their earnings as NIC, when self employed only pay 8% and self employed people with limited companies can pay none at all.
OK. That's the chip on my shoulder dealt with.
A useful part of the armoury is the 'confirmation of arrangements' in which the client agrees explicitly that working practices do not amount to 'disguised employment' - see Roger Sinclair's summary here:
http://www.egos.co.uk/ir35.htm#CoA
This helps avoid the situation where HMRC questioning of a naive client allows things to go their way.
Other practitioners offer similar services !
I have a new client who is a software programmer. He will work for the client via an agency. He has already started a limited company (the client or agency required this).
As he is my first client to do this, could anyone give me some advice as to the best way to handle this?
The case is similar to Nichola's example.
He will earn about £85k, work away from home, and contracts are likely to be less than 2 years.
He wants to use up his personal allowance under PAYE and draw the rest as a dividend. Can he do this, and what points do I need to be wary of?
Urix.
@Neil
But you always need to remember that "an employee earning the same income" will have a package including sick pay, paid holidays, training courses, pension, employment protection legislation, relocation allowance and other benefits.
Additionally you need to be very careful with what appears to be a straightforward phrase, "the same income" since is that post-tax or pre-tax ? And don't forget that to be 'fair' about amount of tax you would need to include, as tax paid, the employer's NI paid by the employee's employer.
Also an employee would have to pay travel and accommodation etc. out of taxed income whereas a freelance worker need not, 24 months and other legislation notwithstanding.
So many factors to be taken into account.
Unless John's counsel was a solicitor advocate the Law Society would not be interested in counsel's conduct. A solicitor is not counsel in the context of the legal system in England & Wales.
If it was a barrister, the reference should have been to the Bar Council as that is the regulatory body.
If it was a barista there are better places than Starbucks.
John come on, the way you wear a computer chip on your shoulder does little to help win support for your cause.
John seems to have a chip on his shoulder.
It's not a matter of the establishment picking on IT Consultants.
It comes down to inherent unfairness in the tax system.
Somebody who is able to arrange to work through a limited company can pay significantly less tax and national insurance than an employee earning the same income.
Accountants and tax advisors don't work for the establishment but we do have to ensure that our clients are aware of the rules and do our best to ensure that they don't fall foul of them.
I'm just trying to ensure that accurate and balanced statements regarding IR35 are made. Members of the "establishment" clearly can influence the issues far more than I can and surely as a result of this have a duty to ensure that statements are accurate and balanced. Anyway, no offence intended, just heed the advice of an old man with many years of life experience and over 40 years in IT! Informed opinion once had it that the Earth was flat!
you have lost my sympathy and my attention. You were doing so well too!
It was just that it seemed I was well ahead of the game when I took on HP and Certes in the EAT, which was directly as a result of IR35. However, I'm still convinced that there was political intereference in my case, because the implications for employment law I believe were significant. HMG could afford to let me off the IR35 hook, but could not risk a judgement in my favour regarding employment status.
Just by the way, to demonstarte why I'm so sceptical about the "establishment", my legal counsel withdrew from presenting my case just 5 days before the scheduled date and did nothing to apply for an adjournment. A complaint to the Law Society drew a blank. Further reasons for me to believe the case was manipulated politically.
So IR35 is a political tax and has nothing to do with fairness. It's just another stealth tax. I agree that it's IT consultants who seem to be most affected by IR35, and despite what HMG say, we are its intended targets. However, with the "family business tax" there could be more collateral damage as well as the intended targets again - the IT community. Remember the Arctic case was an IT consultancy and HMG are hell bent on getting revenge. When faced with issues like this, I advocate guerilla tactics, much like my case against HP. Of course, you being part of the "establishment" have to toe the line, because you need to maintain a working relationship with HMRC. I don't have that baggage.
So, it would be useful, as you've indicated, to steer away from giving examples around IT consultants and use more examples from the "professional" community. At least then these groups will be aware of the threat from IR35. Incidentally, my current client uses accounting personnel on the same basis that I'm contracted. So there are examples in the accounting area of those who are targetted. Perhaps it might be more appropriate to research the issues more broadly rather than depend on your own personal experiences to form an opinion.
IR35 went to judicial review and we are stuck with it. Do not forget that income shifting has only been postponed - something far nastier may evolve in its place.
I really mean no offense it is just that I meet and hear about more IT consultants with potential IR35 problems than any other group of contractors. Nearly all the tax cases feature this group of workers too.
Most other sorts of professional consultants that I meet on my travels, such as accountants, architects, engineers etc tend to operate commercial multi client practices, or are contracting via agencies under PAYE. Since nannies and domestic workers were brought into IR35 I suppose I could have used these too. Anyway, point taken, I will use some other sorts of professional next time to balance it all out.
So Nichola, you agree that your second statement is incorrect? I labour the point to demonstrate that even the advice and opinions of our eminent professional colleagues is not always correct. So is it any wonder why there is so much resentment in the IT community against IR35? Despite what I refer to as my personal armour (see John M. Williams vs. Hewlett Packard and Certes at the EAT December 2002 judged by Mr. Justice Elias - you should read the judgement and see how I presented my case in order to discredit IR35), I continue to monitor opinions and activities surrounding this spiteful Socialist tax. More especially, I continue to challenge opinions and statements which are clearly incorrect or are biased against the IT community. Sorry, but I'm watching you all.
I note that despite my earlier criticisms, you still give the example of an IT consultant. Please let's see some examples about accounting consultants or architect consultants. I'm afraid Nichola, you keep presenting the establishment line by pointing at IT consultants.
Yes, look at the relationship between the worker and the end client - employed or self employed?
Employment status is an issue if you are engaging workers in any type of business.
So if you happen to be a CIS contractor you will need to check out the employment status of your workforce. If they are self employed then pay them according to their gross or net status within the CIS scheme. If they turn out to be employees, then run them through your payroll and deduct PAYE and NI from their earnings etc.
Employment status cases in the building industry do come up from time to time, but IR35 in the building industry is in my experience pretty rare, as most individual contractors do not need to operate though companies or partnerships and the ones that do are building companies and could never be in deemed employment in any case.
Hi Nichola,
You stated that IR35 applies when -
"an individual personally performs services for a client, and
the contract to supply those services is made between the individual's own limited company, or partnership, and the end client, and
the circumstances of the arrangement are such that, if the individual had contracted directly with the client, he would be regarded as an employee of that client."
your second statement states that the contract must be between the consultant's Ltd. Co. and the client directly. This intimates that where the contract is between the consultant's Ltd. Co. and an agency, to supply services to a client, then this situation is not caught. I don't believe that to be the case.
HMRC are ignoring all intermediaries and looking at the relationship between the "worker" and the recipient (the client) of the services directly.
Many IT consultants, including myself, use the corporate structure but trade through agencies whilst providing the service to the client. There are also structures where a consultant trades with an agency through a software house who in turn trade with the client, the consultant perhaps working at the software house's premises, but on the client's machines.
Additionally, under this structure, the consultant can work at the client's site. I think HMRC might have difficulty with this structure.
So in summary, I believe you should verify your opinions with the actual circumstances which prevail in the market place. However, I'm always here to advise you!
Nichola,
Construction industy practice is to use subcontractors (either self-employed or via limited companies). Does this common practice 'override' / a defence against IR35?
One client seems to work for just the same contractor continually (several years), but on different building projects. Contractor habitually uses subcontractors rather than employ staff.
Your view would be appreciated.
Thank you.
Thank you for that, I was wondering how long it would take someone to comment! Really, there are not enough details here to decide this.
I put it the way I did quite deliberately, because were Bill in this example not under IR35 then presumably other factors might have come into play which may mean that home was also a permanent workplace. Bill, we assume thought that home was a workplace before he found out that IR35 applied - he was charging his company rent after all.
Obviously, it is not too easy looking into the mind of a fictitious character (!), so I will just have to guess that he might have interpreted the depot rule as meaning that home was his depot (and therefore permanent workplace). Alternatively, as home housed his secretarial assistance and equipment he probably thought that home qualified as a permanent workplace where his employer (his company) was based and so then he would treat a visit to a client as workplace to workplace travel.
The point that I really want to make is that if IR35 applies, you have to reassess as if your end client is your employer and this is where you can find that travel and other costs are no longer valid deductions.
I think it's worth pointing out that the reason that the travel and subsistence costs are not allowed under this example is because the contract is for longer than two years and it is no longer a temporary workplace. It's not because IR35 disallows them. It is only where the service company is caught by the MSC rules that such costs are automatically disallowed regardless of the two year rule.
