Explantion 1) Supplied by Competex Ltd

The following guidance notes include information taken from the HM Revenue and Customs (HMRC) web site, which is constantly being up-dated (http://www.hmrc.gov.uk/ir35/). We are only able to set out the general principles relating to IR35 and, although we shall try to assist wherever possible, you should seek legal advice if in any doubt. IR35 is based on employment legislation and HM Revenue and Customs have published an Employment Status Manual at:
http://www.hmrc.gov.uk/manuals/esmmanual

Background to the rules

In April 2000, new rules were introduced which affect the way personal service companies (PSCs) were to operate, so as to remove opportunities for the avoidance of tax and National Insurance Contributions (NICs). The rules are not intended to prevent workers from providing their services through a PSC, but rather to discourage the practice of routing engagements through PSCs simply in order to take advantage of a more favourable tax and National Insurance regime.

The IR35 legislation is only applicable in certain circumstances depending on an individual’s ‘employment status’, which in turn is determined by employment legislation.

Identifying engagements where the rules will apply

The legislation applies to anyone supplying his or her services to clients through a PSC, and whose contract would have been a contract of employment with the client, if the worker had worked directly for the client instead of through the PSC. IR35 applies only if the contract provides for services to be carried out personally.

The rules apply in respect of each engagement, in the same way that the rules of self-employment apply to individuals operating without service companies, and the facts of the case will take precedence over careful drafting of contracts.

The 'self-employment' test

For income to be classed as non-IR35 income, you need to be genuinely self-employed. However, there is no statutory definition of 'employment' and the following is offered only as a guide.

If you can answer 'yes' to most of the following questions, you are probably employed and therefore subject to IR35:

• Do you yourself have to work rather than hire someone else to do it for you?
• Can someone tell you at any time what to do or when and how to do it?
• Are you paid by the hour/day/week/month?
• Can you get overtime pay?
• Do you work set hours, or a given number of hours a week or month?
• Do you work at the premises of the person you work for, or at a place or places he or she decides?

If you can answer 'yes' to most of the following questions, it will usually mean you are self employed and therefore not subject to IR35:

• Do you have the final say in how the business is run?
• Do you risk your own money in the business?
• Are you responsible for meeting the losses as well as taking the profits?
• Do you provide the main items of equipment you need to do your job?
• Are you free to hire other people on your own terms to do the work you have taken on?
• Do you pay them out of your own income?
• Do you have to correct unsatisfactory work in your own time and at your own expense?

Many workers will be able to answer 'yes' to questions in both sections. However, in addition to the above questions, HMRC will look at the degree of control you exercise and the basis on which you are paid, as well as the wording of contracts, and no doubt other factors, to determine your status.

They have emphasised that in assessing your work they will take into account all the factors and will not rely on satisfying one aspect; for example, the wording of the contract.

Under Code of Practice 10 (Information and Advice), local HMRC offices are prepared to give written decisions about employment status for tax and NI purposes, and therefore you can obtain a decision on the application of the new rules to individual contracts, but they will give decisions only for existing contracts, and not for prospective contracts.

Relevant engagements – IR35 or non-IR35

An interim management assignment where the contract is to cover for an employee (maternity/paternity leave, or temporary director/manager) will probably be regulated by IR35, whereas an assignment for a project or consultancy work will probably not be. It may be that some assignments come within IR35 and other assignments do not, in which case you will have two pools of money and you will have to apply the rules to one pool and not to the other. Equally, an assignment may require 3/4 weeks assessing the action need in the client’s company, before reporting to the directors and then commencing the work, and in that situation the contract can be split between IR35 and non-IR35 work.

The decision as to whether income from a particular engagement should be subject to the IR35 rules must rest with you, partly because you know your business best and partly because as a director of your company, you must take the responsibility. Obviously, your accountant will aim to give you as much information as they can to enable you to make a decision, but please remember that he or she is not the final arbiter and it is not your accountant that you have to convince! In any event, it is essential to keep detailed notes about the nature of your work and your reasons for deciding that it is inside or outside IR35, as you might be asked questions about your decision sometime in the future.

Your accountant will ask you to sign an annual statement setting out your status for each assignment, so that we he or she can sign a P35 on your behalf.

If you feel that your work is borderline, you have three choices:

1. You could comply with IR35
2. You could seek a written decision from HMRC and abide by their decision (not recommended). An application to HMRC can be made only in writing and, having done this, the only means of appeal would be to the tax commissioners
3. You could seek a written opinion from a lawyer. Most lawyers are familiar with this area of the law and you would be able to make your own representations face to face. HMRC might choose not to contest a case where the tax payer has a legal opinion in writing, for fear of losing, and this is probably the preferred route

As a director of your company it is you, and not your clients, who will be responsible for operating the legislation. It is not necessary for your clients to check whether or not the legislation applies to you when they enter into a contract with your company, nor to conduct checks on the status of your company.

Calculation of salary

In simple terms, IR35 states that: ‘In respect of work carried out after March 2000, if through your company you are doing the sort of work for your (ultimate) client that would normally be undertaken by an employee working directly for that client, then 95% of the income (fees and expenses) received by your company, excluding VAT, must be paid in salary and employer’s NI contribution to you, the individual who earned those fees.’

The calculation must be based on your total income (fees and expenses) and from this total certain permissible expenses may be deducted as set out in the ‘IR35 payroll calculation’ form. The resulting figure is the total of salary and employer’s NI contribution for the period and is the amount that you should pay into the Competex Client Salaries Trust A/c. We will calculate the split between gross salary and the employer’s NI contribution.

Expenses

In calculating the amount that must be devoted to paying your salary, your company may deduct the following expenses from the money received in respect of relevant engagements:

• A flat rate 5% of the gross payment for the relevant contracts. This is intended to cover the various miscellaneous expenses of running your company, including the cost of seeking contracts. This will be allowed automatically, and need not be set against specific expenses
• Any employer pension contributions made to an approved scheme which are allowable under normal rules and professional indemnity insurance premiums
• Computer equipment. You may claim a deduction in the IR35 calculation for capital allowances in respect of computer equipment purchased by your company, provided that you are required to use your own equipment to carry out the assignment
(However, you may not claim a deduction for the cost of purchasing your own equipment if your client provides you with all the equipment that you require, even if your contract states that you should own your own equipment)
• Professional subscriptions where related to the engagement
• Certain benefits in kind (e.g. private medical insurance), on which employer’s NI is payable
• Expenses currently allowed under the Schedule E expenses rule, such as business travel and subsistence costs including accommodation and meals when working away from home. Such expenses must be expended wholly, exclusively and necessarily in the performance of the duties of the relevant engagement
(Travel expenses. If you are continuously employed by your Service Company and undertake contracts for clients of your company in different places, provided that each of your assignments last for no more that 24 months, your client’s premises are treated as temporary places of work and you may claim a deduction for the cost of travel to and from your client’s premises. You must stop charging for travel once your assignment goes over 24 months or from the time that you know that it is going to exceed 24 months, whichever is earlier. If an assignment lasts for more than 24 months, but you do not expect to work at your client’s premises for more that 40% of the time, you may also claim the cost of travel to and from your client’s premises. You may claim these travel expenses both in the IR35 calculation and as an expense for corporation tax purposes)
• Use of home as office. You may claim £2.00 per week without receipts (but see our separate handout on this)

Please note that the cost of training is specifically excluded from the formula.

Company accounts

You should appreciate that IR35 simply imposes a formula for calculating the salary that you must draw from your company, but having calculated how much to take as salary, your company accounts will be prepared on exactly the same basis as has always been the case, and normal corporation tax rules will continue to apply. The 5% allowance does not feature in your accounts.

The consequences of IR35

Because IR35 forces you to pay a large part of the company income to yourself as salary, it is most unlikely that you will be able to pay dividends or a salary to your spouse. Also, because the allowance for running your business is only 5%, the company may be short of funds, and therefore may not be able to pay all the expenses that you would like to pay out of the cash that remains.

We recommend, however, that you continue to pay expenses out of your company, although you will have to loan taxed money back to your company if the expenses exceed the cash available. Financially, there is no difference between paying expenses out of your own taxed income, and lending taxed income so that your company can pay these expenses; but if your company pays the expenses, this crystallizes the expense as a company expense and you can reclaim any VAT if appropriate. Furthermore, there may come a time when you develop an income stream that is not subject to IR35, and you will then be able to repay your loan, instead of having to pay salary. If you do need to lend your own money to the company, please lend a round sum amount and draw out the exact amount due to you as expenses.

By lending funds to the company in order to pay expenses, you will be building up a deficit on your profit and loss, and you must expect this to result in a negative balance sheet. You might also think that the company would be trading while insolvent. However, this would not be the case, because your company is not buying and selling goods and holding stock, and it would always be able to meet its debts as they fell due.

Review of fee levels

There is no doubt that you will pay more tax and national insurance under IR35 than you would otherwise do, and in particular you should be aware that employer’s national insurance (at 12.8%) must be paid on your total gross salary (i.e. the amount used to pay salary includes the employers NI contribution). It is therefore important that you ensure that you are comfortable with the daily rate you are charging your clients.

Relevant case law

For recent legal cases in the area of IR35 we recommend visiting the Professional Contractors Group (PCG)’s website.

For legal advice on whether you should be operating under IR35 or not, Competex recommends Accountax Consulting.

Competex Ltd is a corporate accountancy practice specialising in accounting for interim managers and management consultants who are required to operate through their own limited company. Competex owns the Interim Hub, an open resource on the web for interim managers and an acclaimed provider of training workshops for interims. The Interim Hub runs the Interim Management Induction workshop, endorsed by the Interim Management Association (IMA).
 

Explanation 2) Exploding the myths surrounding IR35 

Principal for and on behalf of Hillier Hopkins LLP

"We are regularly confidently informed by clients that they are not caught by IR35 because their contract is for less than 12 months and that, according to their reliable mate down the pub, is the end of that.  Others with similarly knowledgeable acquaintances have been outside IR35 due to the fact that they work from home, have two clients or provide their own laptop.

The fact is that  none of these factors are conclusive. There are, however, three factors which are conclusive.  Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance [1968] 2 QB 497 initially confirmed this and has not been superseded by subsequent case law.

If none of these factors are relevant in the circumstances then other factors, such as those mentioned above, will be considered and there will be a seesaw type situation.  There will be various factors pointing towards employment and others pointing towards self-employment.  These need to be placed on the seesaw.  The more important factors will be placed further away from the fulcrum and the way the seesaw balances determines whether one is self-employed or employed.

Going back to the three conclusive factors, these are as follows:-

Substitution - If one has a right of substitution which is not unreasonably fettered, one cannot be employed.  If the end client or agent has the right to insist upon giving prior written consent to a right of substitution, this would be an unreasonable fetter.  However, if prior written consent is required, but such consent cannot be unreasonably withheld, that would not be an unreasonable fetter.

Control - One cannot be caught by IR35 if the end client doesn't have the right of control over the way the services are delivered.  This is the most difficult of the three factors to prove.  It is helpful if the contract has a clause stating that the client has no control but this may be disregarded if this is not the case in practice.

Mutuality of obligations  - This is the obligation on the employee to accept work and the employer to provide work on a continuing basis.  It is more difficult to apply this concept to an interim manager than a permanent employee.  For this reason, HMRC have chosen to disregard this concept.  However, as a result they have lost a vast number of cases in the courts.

In practice, there are two ways of applying the concept.  It is possible that a contract will specify terms and conditions including day rate etc but will state that there is no guarantee of any work.  More commonly, if the contract is to perform a discrete, clearly definable project, and once this is complete, there will be no obligations on either party, this should be sufficient.

This article is based upon current case law which could be subject to change in the future.  You should always take professional advice on your contract to take account of your particular circumstances.

Joel Harding

Principal

For and on behalf of Hillier Hopkins LLP

Direct dial: 01923 809414  Mobile: 07980 294740

E mail: joel.harding@hhllp.co.uk