All About IR35
What can I do to prevent it applying to me If it applies, what can I do to reduce it's impact
IR35 is a term used to refer to HMRC's "Intermediaries Legislation" which was first introduced in 1999. The aim of the legislation is to eliminate the avoidance of tax and National Insurance Contributions (NICs) through the use of intermediaries, such as Personal Service Companies or partnerships, in circumstances where an individual worker would otherwise -
So basically, it's HMRC's attempt to avoid people setting up their own limited companies to take advantage of the tax/NIC breaks that would otherwise be unavailable to them if they were employees of the end client subject to PAYE tax and NIC like any other employee.
Sounds fair enough so far, doesn't it?
Unfortunately not, because it drags in all those people who really aren't "employees" and who have adopted the contracting lifestyle of moving from contract to contract, completing a particular project and then moving on, as opposed to those who act like permanent employees. Another factor is that a lot of agencies will only use contractors who have formed their own limited company, so employment or self employment as a sole trader isn't an option anyway for such people who are basically forced into using a limited company vehicle.
Anyone who provides their own services through a partnership or their own limited company is potentially caught by IR35. Those who basically act like an employee, do the same work as in-house employees, are paid by time worked, are closely controlled and supervised are almost certainly caught by IR35. Those who buy/sell goods, like shops, or those who employ others to "do the work" rather than themselves, are almost certainly not caught.
There's a massive "grey area" between these extremes, and unfortunately the goal posts seem to keep moving with every court cases that passes. For example, at first, a good "substitution clause" in the contract was thought to be a clincher for IR35 not applying, i.e. the contract allows for the company to send someone else to do the work rather than the director. Recent cases have overturned this assumption and now the case seems to be whether the end client would actually accept such a substitution, and more worryingly whether the company would actually be able to quickly find and provide a suitable substitute - if not, then IR35 would appear to apply, not based on the wording of the contract, but based on the commercial reality of the situation!
At the end of the day, the contract is now only part of the bigger picture. More emphasis is being placed by HMRC upon the actual working practices and HMRC now appear to regularly ask the end client directly for details of the actual working relationship, which is often not in accordance with the actual contract. More worryingly, and again, bad for the contractor, is that the contract between the agency and end client is often not the same as between the contractor and agency, so HMRC would argue that the contractor:agency contract isn't relevant and so a "good" contract to avoid IR35 may not achieve that at all if the end client tells HMRC something completely different!
So, to avoid IR35, you, as the contractor, trading via your own partnership or limited company, must ensure that your actual working arrangements and relationship with the end client would pass HMRC's employment status tests as per their website:
http://www.hmrc.gov.uk/employment-status/index.htm
The most important factor, in our opinion, being whether you properly accept business "risk and reward", i.e. whether you have the ability to profit out of the work by using other, cheaper workers, or doing things more efficiently, thus reducing time or increasing returns, and whether you bear risk of reduced profits or losses if things don't go according to plan, i.e. having to pay compensation or accept a lower fee for substandard work, etc.
It matters because the tax/NIC due under IR35 can easily be thousands or even tens of thousands of pounds per year even for relatively average earning contractors, and can therefore mount up to maybe over a hundred thousand pounds over several years, especially with potentially high levels of interest, surcharges and penalties!
Literally it could cost you your home if you ignore IR35 and get caught and forced to pay the tax/nic that should have been paid, plus interest, penalties etc., especially bearing in mind that penalties could be 100% of the tax/NIC due, i.e. could double the amount due!
It matters because if you accept that you are caught by IR35, you can mitigate the tax/NIC costs by changing the way you operate and pay yourself. For example, if you know and understand the expenses that are allowable under IR35 you can maximise your claims and thus reduce your exposure to IR35. You can also reduce your tax/nic by your company paying employers' contributions into your private pension scheme. You may also benefit by your company providing you with a company car (and maybe fuel) which is usually a no-go for a company where IR35 doesn't apply!
So, you need to know whether or not you're caught. If you are caught, you need to know what to do to reduce the damage, and more importantly, need to pay the tax/nic due on time to avoid interest, surcharges and penalties, thus potentially halving your eventual exposure.
It all depends if you're caught!! If HMRC never discover that you were caught by IR35, then probably nothing will ever happen and you walk away unscathed! However, that's not a particularly good way to run your finances.
If you simply ignore IR35 and are caught by HMRC, then they are almost certainly going to issue a demand for the tax and NIC that should have been paid, together with hefty penalties, probably in the 50-100% range as they would regard your failure to apply IR35 as deliberate and dishonest. You can't simply close down the company to avoid paying it as HMRC have the ability to issue a personal liability notice against directors who willfully decide not to pay tax/nic due to HMRC.
To reduce the risk of such high penalties, you should evaluate your contracts and take professional advice as to whether or not you are caught by IR35. There are several specialist IR35 contract review firms such as QDOS Consutling, Bauer & Cottrell, Lawspeed, etc, who for as little as £100 will review your contract and working practices and give you a professional opinion as to whether or not you are caught, and advice as to how to reduce your risks of being caught by changing your working practices and renegotiating your contract, etc. Well worth the cost for peace of mind, and more importantly, if you are subsequently caught by HMRC who argue IR35 applies, you would be in a strong position to negotiate much smaller penalties as you had taken professional advice and thus your actions weren't negligate, deliberate nor dishonest, but merely innocent or negligent, which attract much smaller penalties, if any at all!
By ignoring the issue, you will fail to take advantage of opportunities to mitigate the damage, i.e. by making employer pension contributions or restructuring your expenses or benefits in kind etc., none of which can be repaired in later years as you don't have a time machine and usually can't backdate pensions, or make retrospective changes to expense claims, methods of payment, dividends, payroll, etc.
What can I do to prevent it applying to me?
You should do all you can to change your working practices and contract to exclude anything that points towards IR35 applying and to include things that help prove you are a "proper business" and not a disguised employee.
If you have a "good" contract with all the right clauses then make sure that your actual working relationships and working practices follow the contract to the letter. Also make sure that your agency has a "mirror" contract between itself and the end client, which "mirrors" the same terms as between you and the agency, i.e. if you have a valid substitution clause, then you must ensure that there is similar in the contract between the agency and end client. Whilst your agency will probably not let you see their contract with the end client, most are happy to provide a simple letter or email confirmation that the clauses, T&Cs in your contract are the same in their contract with the end client.
Keep evidence that you are a "proper business" and not a "disguised employee". If an enquiry starts a few years after the contract has ended, you may have forgotten exactly how you worked, what you did, etc., so keep files and make notes of things like emails between you and the end client, internal memos, reports, appraisals, meeting minutes, etc. Basically keep everything you can to show that your contract included business risks & rewards, that you used your own equipment, that you worked outside normal office hours, that you worked unpaid, that you put right substandard work at your own cost/time, that you were paid by the contract/project rather than by the hour, that you weren't treated the same as other employees (i.e. different office, different car park, not joining in staff activities, not on staff "in/out" boards, not on internal staff telephone number lists, etc etc. Literally every little thing that separates you from their other employees! Keep emails and letters between you and the agency or end client prior to your appointment and of course, needless to say, keep copies of all your contracts!
Don't accept assurances from your agency or end client that the contract is "IR35 friendly". It's you, not them, who will have to bear the consequences if HMRC successfully argue IR35 should have applied. It's you, not them, who has to pay the back tax/NIC and penalties. You must do your own research and take professional advice to satisfy yourself that you are operating outside IR35. You should also take out some kind of tax enquiry insurance to cover the accountancy and legal costs of defending yourself against HMRC challenge as this can easily also amount to several thousand pounds for even the most basic of tax enquiry, rising to tens of thousands if it ends up in a court case!
If it applies, what can I do to reduce it's impact
For a start, make sure you understand what it means, how you have to pay yourself and how the tax and NIC will be calculated and be paid.
Then, think about what expenses are allowable under IR35, maximise your claims, think about your company providing taxable expenses and benefits in kind, such as company car and maybe car fuel. Don't forget the company's ability to pay employers' contributions to a personal pension scheme.
Don't ignore it - it's more important than ever to properly plan ahead and maximise your reliefs. You can't backdate and can't turn back time, so once each tax year end passes, you're tax/nic for that year is fixed and has to be paid within days of the year end!
Whether or not you think you're caught, we strongly recommend membership of the Professional Contractors Group (PCG) - the professional association for UK freelancers, contractors and consultants, which you can join for as little as £120 p.a. for basic membership, for which you'll enjoy support and resources to help you understand and mitigate IR35, and also support their lobbying for a change in the law. |