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IR35 business entity tests published

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9th May 2012
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HMRC has begun the process of overhauling its operation of the IR35 regime for personal services companies with new guidance that sets out some basic risk factors that will affect a contractor’s chances of being investigated.

The overhaul will mean an increase in IR35 investigations, the tax department confirmed.

As expected following leaks last month, the 12 business entity tests set out in HMRC’s 47-page intermediaries legislation guidance note are illustrated by six example scenarios. HMRC said the tests are designed to build up a picture of how a contractor’s business works and how they provide their services. The tests and their scores include:

  • Business premises test  - Does the business own or rent business premises separately from the contractor’s home or end client’s premises? (10 points if yes)
  • PII test - Does the contractor need professional indemnity insurance? (2 points if yes)
  • Efficiency test - Has the business had the opportunity in the past two years to increase its revenue by working more efficiently? (10 points if yes)
  • Assistance test - Does the business employ any workers who bring in at least 25% of the yearly turnover? (35 points if yes)
  • Advertising test - Has the business spent over £1,200 on advertising in the past year; entertainment does not count as advertising (2 points if yes)
  • Previous PAYE test - During the past year, has the end client engaged you with no major changes to your working arrangements (Minus 15 points if yes)
  • Business plan test - Does your business have a business plan with a regularly updated cash flow forecast, and does it have a business bank account, identified by the bank as such and separate from your personal account? (1 point if yes to both parts of the question)
  • Repair at own expense test - Would the business have to bear the cost of rectifying any mistakes? (4 points if yes)
  • Client risk test - During the past two years, has the business been unable to recover payment amounting to more than 10% of yearly turnover? (10 points if yes)
  • Billing test - Does the business invoice for work carried out before being paid and negotiate payment terms? (2 points if yes)
  • Right of substitution test - Does the business have the right to send a substitute? (2 points if yes)
  • Actual substitution test - Has the business hired anyone in the previous two years to do the work it has taken on? (20 points if yes)

The scores used to assess contractors’ risk profiles are as follows:

Less than 10 points        High risk
10-20 points                    Medium risk
More than 20 points        Low risk

The HMRC guide explains that the tests are not set in stone, and are an extension of the risk-based approach to extends to all of its investigations.

Paul Mason, manager of the contractors division at investigations insurance specialist Abbeytax, met with HMRC officials this week to discuss the new tests. “HMRC’s new approach hasn’t changed a great deal,” he told AccountingWEB.

“They already undertake risk assessments of who is most likely for investigation. The business entity tests are something you can use to self-assess to see how you score by their internal rating. But they aren’t telling us what the detailed risk criteria are because of the fear people will arrange their affairs accordingly.”

As every other adviser or specialist in this field would agree, Mason added that the business entity tests are just a diagnostic tool. The actual application of IR35 will always come down to employment status factors that must be tested against case law going back to the 1968 Ready Mixed Concrete decision.

But along with the new guidance, Mason did learn that HMRC is drawing together specialist IR35 teams at offices in Salford, Edinburgh and Croydon to pilot the new approach to investigations. The objective of the exercise will be to address the risk of avoidance of employment taxes, including National Insurance, according to HMRC. “This will mean that there will be an increase of the number of investigations opened for IR35 reasons over the coming year and subsequent years,” a spokesman confirmed to AccountingWEB.

He explained that the new operational approach to IR35 will involve:

  • Strengthening specialist teams, to reduce the length of time an IR35 enquiry takes.
  • Tighter risk assessment process to select the highest risk cases for review.
  • At the start of an enquiry, HMRC will take into account a contractor's reasons why they think IR35 does not apply, along with evidence to support their view, rather than asking for a long list of documents.
  • Beefed up helpline/review service for contractors staffed with specialist staff who can offer informed opinions on IR35.

“In the past, HMRC had people dotted around the country who dealt with IR35 enquiries. Now having specialist teams to police the legislation should lead to a more consistent approach,” said Mason.

Dave Chaplin of ContractorCalculator.co.uk was underwhelmed by the new guidance. “HMRC has chosen to retain the same scoring that will be applied to contractors’ answers,” he said.

“This would appear to put the vast majority of genuine limited company contractors at medium or high risk of their businesses being branded as not being genuine companies. And the result of that may well be HMRC continuing to waste time and resources investigating cases it has little or no chance of winning.”

Replies (59)

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By Psyche
10th May 2012 20:55

Ways to escape IR35

So it appears that in advising clients on how to avoid IR35 under the new points system, the following actions could be taken:

- Form a two-person limited company, with two contractors (each with a separate class of shares for dividends) who are each earning approximately 50% of the fee income -- thus passing the assistance test.

- Rent time-shared office space to pass the business premises test.

- Get the client to agree to accept a substitute for one day every two years, thus passing the actual substitution test.

Any other ideas?

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Replying to howardharris:
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By frustratedwithhmrc
10th May 2012 21:18

Look out for the small print on this one

Psyche wrote:

So it appears that in advising clients on how to avoid IR35 under the new points system, the following actions could be taken:

- Form a two-person limited company, with two contractors (each with a separate class of shares for dividends) who are each earning approximately 50% of the fee income -- thus passing the assistance test.

- Rent time-shared office space to pass the business premises test.

- Get the client to agree to accept a substitute for one day every two years, thus passing the actual substitution test.

Any other ideas?

I strongly suspect the small print on this will be extensive, particularly:

1. Two-person company - Easy to do in theory, harder in practice due to varying income from each person, different cost basis, dividend distribution (alphabet shares)?, etc.

2. Business Premises Test - Expect HMRC to define the "Business Premises" to exclude hotdesk and time-based office rentals.

3. Substitution - Difficult to agree the substitution test during initial contract negotiations, possible after extensive working with the client though.

Given HMRC's previous form on IR35, I would expect their interpretation of these rules to be based upon conditions that are set idiotically high, are completely unrealistic or more likely meaningless.

If we play HMRC's game we'll just end up advising clients to do stupid or meaningless activities for no benefit to either the client or ourselves.

 

 

 

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Locutus of Borg
By Locutus
10th May 2012 23:18

If you follow the logic HMRC have adopted ...
If you follow the logic HMRC have adopted for personal service companies then surely if your Schedule D self employed plumber gets a low score then he / she is not really self employed ... so you the customer ought to be setting up a payroll scheme every time you want your burst pipe fixed!!!

The Courts / Tax Tribunals will see through all this nonsense. Accountingweb, the PCG, etc should run a "how low can you go" competition to find out what is the the lowest score that a personal service company can get on the HMRC tests and STILL win in the Courts / Tax Tribunals. I suspect it would be well into negative territory!

I still can't get my head around HMRC's bizarre conclusion that ACTUALLY making a substitution gives you 20 points (should be more like 1,000) when the Courts have always decided that if there is a GENUINE right to substitution then the contract CANNOT be one of service, so consequently IR35 cannot apply.

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By dhalsey
11th May 2012 11:03

Not just personal service companies...

Well, according to this points system, we have a £1million turnover insurance company who are "medium risk". They operate from a home office, don't lose 10% of income, don't use substitutes and don't need PII and the director was employed previously. Needless to say, they're about as far removed from IR35 as could possibly be. They now rent office space and have 20 employees. Still medium risk?

As previous commenters have noted, these tests ignore case law, so HMRC can make up tests until it's blue in the face, but if they target a business who scores highly in its test, they will only then look at it and think, "ah, the Tribunal will throw this one out".

Seriously though, have HMRC got the resources for all this? RTI coming in, pension reform for employers, this points test that should ensure 95% of all PSCs go across their desks....

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By dstickl
12th May 2012 18:27

@KateCottrell: Please support "Contractor's Age test: Is C>SPA?"

Hi Kate Cottrell!   May I politely request - when you attend the next HMRC IR35 Forum meeting - that you please ask the HMRC team members to introduce an additional / new IR35 Business Entity Test question, to those already published, of the form:

*  "Contractor's Age test - Is the contractor aged greater than State Pension Age? (999 points if yes)".

Of course, if HMRC's proposed system can only deal with two digits, then score 99 points (if yes); as, for your easy reference, I previously set out in this AWEB link:-

https://www.accountingweb.co.uk/anyanswers/question/ir35-2#comment-558692

Here are some rationales to support a  "Contractor's Age test", for consideration:

(1) IF HMRC really does support the Chancellor's Budget 2012 for growth, THEN surely it's better that people over State Pension Age (SPA) are in work, creating economic activity for the UK's economy, rather than on the street or buses, or causing extra public expenditure through pre-mature dementia/altsheimers/etc and associated NHS or care home costs.

(2) Haven't the necessary contributions needed by the state already been paid by and for such OAP workers, through the NIC records?

(3) Don't the advances in computerisation since the post WW2 introduction of the NIC scheme mean that employers can now efficiently distinguish between workers aged below and above SPA?  

(4) With the intellectual/skills capital of workers > SPA, isn't it sensible to unleash same, especially as an ageing population demands sufficient workers, and immigration is now discouraged by HMG due to the costs of congestion, etc?

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By mikewhit
14th May 2012 15:18

What should be the intention of this rule anyhow ?

a) Forcing as many as possible into a deemed payment regime, possibly rendering their business uneconomic ...

or

b) Trying to prevent abuse of the Limited Company mechanism by people who are really employees in all but name ?

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Replying to Red Kite:
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By ThornyIssues
15th May 2012 08:24

Preventing abuse

mikewhit wrote:

a) Forcing as many as possible into a deemed payment regime, possibly rendering their business uneconomic ...

or

b) Trying to prevent abuse of the Limited Company mechanism by people who are really employees in all but name ?

 

Unless a person enters into a mutual contract of employment with an employer, they are not and should not be able to be "deemed" employees (particlulary using employment law to dictate tax law). That is what is wrong here! If the Government, on the true facts, are convinced that there is an inequity in the tax take between employees (with all the encumbent "perks" of employment courtesty of their employers) and a freelancer (taking into account "in business" costs, risks, covering sick, holiday and SMP etc) then that should be addressed. Simplifiy tax and merge tax and NIC to level the playingfield and provide clarity and determination.

It's not rocket science!

 

 

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By The Black Knight
15th May 2012 12:06

Pigs ear!

If there was consultation it seems to have arrived at:

A set of tests divorced from reality and the current legal position to discover whether further enquiry needs to be made on a risk assessment basis.....Hello

Clearly this expands the work to be done in this area.

Now we have to explain two sets of conflicting rules to people who will not understand past the first 30 seconds....may be I am getting it all wrong and should shut up and charge a fat fee for this advice....except that is not how it works on the front line. Simplification or what ?

Surely this could have been realistic and much much better.....

There is nothing wrong in principle with a points idea for guidance.(and I welcome this)

But In my opinion the result is a bit rubbish.

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By ThornyIssues
16th May 2012 14:27

Back to a point of order!

"Under the contract between SLC and Penna, all fees for the provision of the interim chief executive will be paid by SLC to Penna. No payments will be made to Mr Lester by SLC or BIS and there is no contract between Mr Lester and SLC or BIS.

We understand that there is a further contractual arrangement in place between Penna and Mr Lester’s personal service company for the provision of Mr Lester’s services. We are not party to the terms of this agreement, but understand that Mr Lester’s

personal service company will have an obligation to operate PAYE and NIC on payments made in respect of the services provided under Penna’s contract with SLC."

So this is a standard agency provided Interm situation. There is a contract between agency (Penna) and SLC agreeing financial terms and agreeing that Penna will provide the SERVICES of an interm manager and a contract between Penna and Mr Lester's LtdCo to provide Penna with said services. There is no contract of employment and describing the work to be done does not constitute direction and control. If you engage a SE brickie, you tell him what you do but he decides how to do it!

While use of "employment" in the document is unfortunate, but it is by no means rare and as such is a continual bone of contention between contractors/freelancers where HR depts get involved in what should be a business-to-business procurement contract! When will they learn?  

Lastly, if Penna have their contractual heads screwed on, there will be an unfettered right of substitution in both the upper contract and that between themselves and Mr Lester's LtdCo e.g. RoS and no MOO.

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