IR 35

IR 35 is a term commonly used when referring to the taxation of individuals working through Personal Service Companies, and became effective in April 2000.

The application of this legislation is dependent upon the interpretation of the provision of personal services which consequently follows employment law. There have been a number of cases passing through the courts over the years some of which have been won by the taxpayer and some of which have been won by HMRC. A notable case to date is that of Dragonfly which was won by HMRC before the Commissioners and also on appeal to the High Court, and following this decision the contractor must act with care. However there are many cases in which the contractor has been successful since the decision.

Application : It applies if the company is a disguised employee of the client for whom it works. The impact of Dragonfly is to enforce the fact one has to look at the relationship between the contractor and the end client as if only one contract existed. So the contract between the contractor and the agency is not the only consideration.

Disapplication : It does not apply if the company is providing its services effectively on a "self employed" basis.

Effect : If caught the income earned by the company is taxed as PAYE income of the director and therefore incurs National Insurance of 23.8%. Such a liability is not imposed if the company is not caught and income is withdrawn from the company by small salary and dividends.

Main Factors : to consider are the contracts (which can be the tie breaker if all else is neutral) and the way the company operates both in relation to the contract and generally. The main issues to address are control, substitution and mutuality of obligation although other factors are mentioned below.

Part and parcel of the organisation : How do you work with the client? Is there "supervision direction and control" over the work carried out? This is an old test of employment status which has been over ridden in modern case law but is still a factor. Try not to become part of the client's organisation and work in different ways to the employees. Perhaps do not use the staff canteen and specify in the contract that you can not! The judge specifically commented that using the client's equipment on site does not fail the self employment test. However I would expect an IT consultant in business on his own account to have his own laptop and PC.

Basis of payment : Most contracts provide for payment by the day or the hour. If payments can be made by milestones or on a project basis this significantly helps. This might be compared to a builder who might sometimes operate on a price and sometimes on a day work basis. Being paid by the day therefore does not preclude self employment.

Running a business : If the company is in business on its own account then it adopts a businesslike approach, has a business set up looking for work with more than one person, advertising (has a web-site), undertaking other work in the evening and weekends. Also recommended are Professional Indemnity and Public Liability Insurance.

The contract : must be with the company and preferably be silent on whose services will be provided. It must specify that a substitute can be sent (although the Revenue state that to be effective it must be an "unfettered right" to send a substitute - you decide not the client). Any substitute should be responsible to and be paid by your company and not by the client. In particular the contract should specify that it creates no "mutuality of obligation". This might be achieved by the contract specifying that the engagement is terminable without notice on either side.

Smell test : overall there is no one thing which points to self employment and judges have said it can not be decided on a check list basis. It is about attitude, do you feel and act as your own boss or as an employee. What is the over-all feel.

Commercial preference : I imagine most contractors would prefer the security of a long contract with one client. That of course goes against the feel of running a business but is not necessarily decisive. A succession of short term contracts helps in making the argument.

If caught : I recommend operating the CTS spreadsheet and drawing the net monthly salary as computed together with expenses incurred. Pay over the PAYE monthly or quarterly. There should be very little if any residual Corporation Tax to pay.

If not caught : Use the CTS spreadsheet but overtype in column 'I' a preferred salary level. This might be £550 per month or more. Draw the net salary together with expenses monthly and a dividend quarterly (bi-monthly if you have to). Again pay over the PAYE monthly or quarterly. Budget for the 21% Corporation Tax payable as shown in our spreadsheet.

If you have any queries about IR 35, any tax issues or simply interested in hearing more about how CTS can help your business, please contact Jon Dale on 01743 235 236 or email jon@saltd.org.