IR35, self employment and tax
The article provides a simple summary of the main legal provisions of IR35 and the main effects. The view we have taken is that of the contractor. At the bottom of the page are links to further IR35 information.
Self Employment Today
The pre-existing position is based on the proposition that a business is allowed to set its costs of operation and materials against its gross receipts. What is left is "profit" and tax is payable on that money. For an employee selling his services under a contract of employment (verbal or written), the option of setting off expenses is not available. Even if an employee does in fact incur expenses (such a travel to work costs) they are not generally allowable against his tax liability.
In order to benefit from the more favourable environment enjoyed by businesses, many sole traders or contractors have formed a "service company" or other company, the principle purpose of which has been to take advantage of the expense offset allowed to a business. The director-shareholder has then been able to draw money from the company as dividend, so making a further saving of the sum he would have paid in national insurance contributions.
This device has been used at all commercial levels. It has become particularly common in the IT sector where it is a fact that many people work in the "no man's land" between employment and contracting.
I refer to the new law as "IR35" for the sake of simplicity. IR35 does not in any way change the proposition that a business is taxed differently from an individual; nor the rules as to what constitutes employment or self employment.
IR35 provides that anyone using a limited company intermediary for his contract work, (we will call him/her a consultant from now), who fails the "self employed" test is now deemed to be in "disguised employment", and will no longer be able to take advantage of the tax regime available to a business. Accordingly, he will have to pay Schedule E income tax and Class 1 NI on the entire amount of money he has received from the company (less certain small allowable expenses).
Who decides whether IR35 applies?
The Inland Revenue of course! It does not matter what written agreement is in place, nor what the parties have agreed, the relevant facts are those available in the round. If the consultant disagrees with the decision, he can appeal to the General Commissioners. The basis of the decision is many years of case law. It is therefore possible to make a considered judgement as to whether a particular set of facts constitutes employment or self-employment.
What can be done?
Despite the comments in the previous paragraph, to start, the consultant must work under the terms of a proper contract for services - a consultancy agreement of some sort. Whilst the existence of such a document is not conclusive evidence of the status of the parties, any such agreement will be drawn in a way that tends to show the relationship as being that of consultant-client, not of employee-employer.
The agreement matters only because of the terms it contains. The terms only matter, first if they tend to show a contract for services and secondly if the parties are complying with them. I deal later with the actual factors, many of which can be included in the agreement. If a consultant works through an agency, it is particularly important that the agreement is in the right form, because "agency employment" tends to fall short of the new rules.
Factors to take into account
- Is there a "business" beyond merely the sale of services of one person? Does the business have a bank account? Does it have stationery and business cards? Is there an ongoing provision for selling the services to new lients? Does the business own all the usual equipment - computer, printer, scanner, fax, etc? What about a copier and more obscure equipment?
- Are there other employees working for the consultant under contracts of employment? (no spouses please!)? This is a very strong marker. We have never come across a case where a business employing others was deemed to be the self-employment of one or more individuals;
- Is the consultant "at risk" in the performance of the contract? The provisions of the agreement relating to liability, indemnity and insurance should make this clear. This is another strong indicator. Employees cannot generally be sued for an accidental disaster consultants can;
- Is the subject matter of the contract expressed in terms whereby the client pays for an outcome or merely for work to be done in accordance with his direction? This includes the timing and method of payment and the degree of control enjoyed by the client. Does the client say how many hours a week shall be worked or where the work will be done?
- Is the consultant at financial risk? Could he make a loss if things go wrong? Can he makemore profit if they go well?
- Is the consultant restricted from working for others? Employees are not generally allowed to have two jobs. Consultants can work for numerous clients simultaneously. Some restriction to prevent assisting a competitor so normal and should make no difference. It isgood if the consultant has more than one client at once, preferably several. Generally speaking, the more clients, the more clearly the business is just that, and not a disguised employment;
- What overhead expenses are incurred? If the consultant operates from a self contained purpose built office (no, not the converted garage!) that points to a business. If he works from the sitting room, the matter is still open. Even for a home worker, the exclusivity of space is important. But beware of allocating space exclusively to business use, 365 days a year, or that proportion will be subject to capital gains tax when you sell the house;
- To what extent can the consultant sub-contract the work? This is not the most important item because it is quite common for a client to insist that the work is not sub- contracted.
Who has to pay the tax and NI?
The responsibility for payment of tax (and subsequent liability for penalties for non-payment) falls on both the Service Company employing the Consultant and (if it does not pay), the consultant himself. Note that he is not protected by the limited liability of his company!). The employing client is not responsible. Note that this is different from a "normal" situation where the Revenue deems a relationship to be that of employer-employee, and where accordingly, the employer has to pay the amount due as PAYE.
What about agencies and intermediaries
Beware of agencies that are not switched on to help. Avoid signing any contract that does not look like a contract for services as set out above. Particularly avoid any commitment to work particular hours, or number of hours, in a particular place or for a particular length of time.
The second intermediary you will find is a new animal;born to grow fat on the worry and concern a consultant might feel. These people use one or more of their own companies to employ you and effectively split the saving with you. Your downside is:
- You are still an employee, not a self employed person, so you still pay tax on the same basis that you would pay if you never went to them at all;
- They “win” by maximising the expenses they can arrange to be offset against your tax as an employee of theirs, and by running a company at lower cost per employee than you could do;
- They take a fee. It has to come from somewhere. It comes from you;
- They (usually) say they have a special deal with the Inland Revenue. The IR website specifically states that they do no general deals, but take each case on its merits;
- They may hold your money for a time, earning interest at your expense;
- They will “hard sell” you on various financial products like pensions and professional indemnity insurance - all at very “favourable rates” of course.
Our general advice:
- Play fair. If your work really is employment, accept that you will have to pay the tax!
- If you are in any doubt, put your case to the Inland Revenue for an opinion. Take a budgeted account; showing what overheads you will have to pay and a narrative explanation of how you will operate. It is likely the outcome will be favourable. Yes, the IR do try to collect as much tax as possible, but they have better things to do than to take on "no hoper" cases where you will make then look foolish before the Commissioners;
- If the IR do not give the answer you want and you feel they are wrong, do appeal. The commissioners are ordinary folk and will give you a fair run. When your appeal has been made, go back to the IR with some additional information. If you give then half a chance to change their mind, they may do so;
- If you really do not want to be "a business" and you want an intermediary employer so as to show a "consultant" presence to a client, and then choose a properly qualified firm of accountants who run such a scheme. Above all, obtain references you can speak to on the phone;
- Don't hesitate for a moment in operating as a business. You do not need a company to qualify for the less unfavourable tax regime enjoyed by businesses. If you can operate a simple piece of accounts software, that is great. If not, just record everything carefully and find an accountant to put it together each month. You will enjoy greater prestige and may be able to charge higher fees for the same work.
Latest new law
The Professional Contractors Group (PCG) is pleased to announce that PCG member Roger Tilbury from Bedford has won his case at the Special Commissioners.
Issues of substitution and control were apparently key factors in the case of Tilbury Consulting Limited v Margaret Getting (Her Majesty's Inspector of Taxes), in which Inland Revenue sought to show that Tilbury was a disguised employee of his end client, Ford Motor Company. His contract was actually with Comp ware, to which Ford had outsourced its application management centre.
In handing down his nine-page judgment, Mr Stephen Oliver QC concentrated on the facts of the case. These included the fact that Tilbury Consulting Limited:
- Had the 'qualified right' to send a substitute but had never exercised this;
- That it was not part of the direct manager from Ford's function to tell Tilbury how to do the work, and;
- That Tilbury had a different colour pass from the Ford employee pass, which did not entitle him to use of the gym.
He also noted that Tilbury was paid by the hour, and that it was not a matter of concern to Ford who provided the services, or that some of the work was undertaken at Tilbury Consulting Premises.
Not Part of Ford's Business:
He concluded that Mr Tilbury would not have been regarded as Ford's employee:
- Firstly because it did not have operational control over how the project was undertaken;
- Secondly because of the right of substitution between Comp ware and Ford and between Tilbury Consulting and Comp ware, and;
- Finally because Tilbury was not part of Ford's business or undertaking.
These factors were, in his opinion, inconsistent with employment.
PCG supported Tilbury throughout the case, and he was represented by Dave Smith of Accountax.
On receiving the judgment, 56 year old Roger Tilbury said, "I'm delighted to have won, and relieved that it's over. It has taken more than two very stressful years to get to this point, during which time I had to put all investment in my business on hold, for fear of tying up funds.
I am very grateful," he added "for PCG's support and for Dave Smith's outstanding representation."
Commenting on the outcome, PCG chairman Simon Griffiths said, "We're very pleased with the judgment. This significant case re-establishes the core principles of defining an employment relationship based upon the actual contract and the facts, rather than trying to construct a notional contract intended to imply employment.
Furthermore, it recognises even a fettered substitution clause as being inconsistent with Employment, despite never having been exercised. Roger has been working for the sameEnd client for nine years, being paid by the hour, and it’s encouraging to note that theissues of control and substitution were deemed more important in determining his Employment status.
Net Lawman comments:
- Evidence of Mr Tilbury’s status came from all three relevant areas:the written agreement; the actual working practice and the situation “in the round”. A good agreement was a crucial feature;
- The right to substitute some other person to do the work was a very important feature in Mr Tilbury’s favour;
- Mr Tilbury won despite being paid by the hour. The Inland Revenue may never have pursued the case this far had he been paid on some other basis.
The Inland Revenue general explanation and guidance is at
Click to buy: Shareholder Agreements
Please note that the information provided on this page:
- Does not provide a complete or authoritative statement of the law;
- Does not constitute legal advice by Net Lawman;
- Does not create a contractual relationship;
- Does not form part of any other advice, whether paid or free.
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