Gabelle Tax Analysis: HMRC introduce IR35 tests

HMRC introduces business entity tests for IR35

In his Budget this year, the Chancellor announced a review of IR35. As a precursor to this review, HMRC issued a guidance note on 9 May which reiterates the basic rules of IR35, and introduces a “risk-based approach” to determine which cases should be looked at more closely to ensure that IR35 is being operated properly.

There are three risk bands, low risk, medium risk, and high risk. With a low risk case, HMRC are unlikely to check whether IR35 should apply. High risk cases are likely to be looked at more closely.

The risk bands are based on a points system which looks at a set of business entity tests. A score of less than 10 points will fall into the high risk, 10 to 20 points will be medium risk, and more than 20 points will be low risk. The tests and the points associated with them are as follows:

  • The business premises test – Does the business have premises which are separate from home and the end client’s premises? (10 points)
  • The PII test – Is professional indemnity insurance needed? (2 points)
  • The efficiency test – Has the business had the opportunity in the last 24 months of increasing income by working efficiently? (10 points)
  • The assistance test – Does the business engage workers who bring in at least 25% of turnover? (35 points)
  • The advertising test – Has the business spent more than £1,200 on advertising in the last 12 months? (2 points)
  • The previous PAYE test – Has the current end client engaged the worker on PAYE terms within the last 12 months to the last 31 March with no major change to the working arrangements? (minus 15 points)
  • The business plan test – Does the business have a business plan with cash flow forecast, and does the business have a separate business bank account? (1 point)
  • The repair at own expense test - Would the business have to bear the cost of putting right any mistakes? (4 points)
  • The client risk test - Has the business had bad debts for work done in the last 24 months amounting to more than 10% of annual turnover? (10 points)
  • The billing test – Does the business issue invoices before being paid and negotiate payment terms? (2 points)
  • The right of substitution test – Does the business have the right to provide a substitute? (2 points)
  • The actual substitution test – Has the business hired someone in the past 24 months to do work it has taken on? (20 points)

The points awarded to the tests demonstrate HMRC’s view of the relative importance of various factors that will be familiar to practitioners in the context of determining an individual’s status as employed or self-employed.

It is important to note that the circumstances of a business must be looked at in the round, and that the points based system only creates a guide as to the risk category and not whether a particular contract is within IR35.

HMRC's guidance note also reminds us of their helpline and review service. Specialists within this team will review a contract, and if they conclude that the contract is outside IR35 they will issue a certificate, valid for three years. If HMRC open an IR35 review the certificate can be used to suspend the review, which will be closed if the contract they reviewed is typical of the engagement terms and conditions entered into by the business, and the information provided is accurate. In our experience, there has been a reluctance among practitioners to use this service to date.

It is clear that HMRC want to make IR35 more effective in attacking personal service company arrangements, and we should expect to see increased activity in this area. 

Paul Howard is a Director at Gabelle LLP. He can be contacted at paul.howard@gabelletax.com or via TaxDesk on 0845 4900 509.