Employed Or Not - How Will IR35 Affect You?
In essence, if you behave like an employee of a client then the Revenue will claim that you are an employee regardless of your company structure. Spend any time at all thinking about the tax treatment of corporate entities in the UK and you’ll soon realise that it offers employers and individuals rich scope for tax avoidance.
Background
With a government determined to load employment costs onto the business sector and increasingly using employment legislation to achieve social change, it’s only natural for employers to seek alternative approaches.
One of the most straightforward cost savings is to reduce the employee pool and move to using suppliers who sell in their services to the organisation. Examples include agency workers, external consultants and resources used for specific projects. This gives the employer the advantage of getting the specific help they need without the overhead of employment costs and social legislation.
For individuals and suppliers who offer these services to employers it gives the chance to have their earnings treated under the more generous company or self employed tax regimes.
Avoidance action
Faced with widespread action by employers acting to change the legal definition of their workers and the resultant decline in tax revenues, HMRC have taken numerous steps to counter this kind of tax avoidance action.
Employed or Self Employed?
Imagine, if you will, an IT contractor sitting on a six month change programme for a blue chip employer. She comes in at the same time every day, logs in to the client computer, attends meetings, takes a normal lunch break and gets treated pretty much the same as the employees she works with.
Apart from one thing; the way she gets paid. Each month her personal limited company sends an invoice, based on time spent, to the employer.
Everybody wins. The employer saves employer’s NI, and the overhead cost of another employee. She saves because her personal service company gives her the ability to minimise her tax bill by manipulating her rewards from this business.
Everybody wins, except the Revenue who clearly take a dim view of this kind of arrangement.
The nature of your contract
Since the late ‘90’s the Revenue have issued guidance notes to Inspectors faced with this kind of situation. The most notable example was number 35 and has entered folk lore as “IR35”. So what exactly does it say?
In essence HMRC take the position that your legal structure does not define your employment status, your behaviour does.
This means that simply creating a personal service company or self employed status as an invoicing vehicle is not enough. You have to actually be behaving in a way that does not constitute employment and the relationship with your client must not look like an employment relationship.
Annoyingly, they will not issue a comprehensive definition of employment, leaving plenty of room for discretionary decisions by local inspectors.
Most of the rest of this section is taken directly from notes that HMRC issue to their own inspectors who are urged to consider the question “What would the relationship be if the legal structure was removed?”
IR35: Countering Avoidance in the Provision of Personal Services
These rules were first proposed in the 1999 Budget news release numbered IR35. They have since become commonly referred to as “IR35”. The purpose of the rules is to remove opportunities for the avoidance of tax and Class 1 National Insurance Contributions by the use of intermediaries, such as service companies or partnerships, in circumstances where an individual worker would otherwise be an employee of the client or the income would be income from an office held by the worker. (Inland Revenue 2004)
Employees - Contract OF Service
Employees have a contract of service. They get paid to perform service. If you can answer ‘Yes’ to most of these questions you are probably an employee:
- Do you have to do the work yourself?
- Can someone tell you at any time what to do, where to carry out the work or when and how to do it?
- Can you work a set amount of hours?
- Can someone move you from task to task?
- Are you paid by the hour, week or month?
- Can you get overtime pay or bonus payment?
In essence, if you behave like an employee of a client then the Revenue will claim that you are an employee regardless of the legal structure you use to deliver the work.
Why is this important?
It’s important because if you look too much like an employee, the revenue will simply pretend that your legal structure does not exist and tax you as if you were an employee of your client. This is not good. It would probably mean you paying income tax on your earnings and your client facing an employers national insurance bill on everything they have paid you.
Not Employees - Contract FOR Services
If the answer is ‘Yes’ to all the following questions then it will usually mean that you are self-employed. (Note that ‘self-employed’ is used in the more general sense of not being an employee of the client).
- Can you hire someone to do the work or engage helpers at your own expense?
- Do you risk your own money?
- Do you provide the main items of equipment you need to do their job, not just the small tools that many employees provide for themselves?
- Do you agree to do a job for a fixed price regardless of how long the job may take?
- Can you decide what work to do, how and when to do the work and where to provide the services?
- Do you regularly work for a number of different people?
- Do you have to correct unsatisfactory work in your own time and at your own expense?
What Should I Do About IR35?
Nothing here is a guarantee because the tests have been built up by case law so you have the situation where the Revenue want to class you as an employee but you, rightly, want to class yourself as self-employed. It’s your job to put the situation beyond argument by the way you run your business and the relationship with your customers.
Use the criteria above to structure your business and work with clients so that there is a very clear probability that you are NOT an employee.
The language can be confusing here. Even if you create a limited company to offer your services, you can still be classed as an employee of the customer if your behaviour is like an “employee”. The Revenue will consider what the relationship would look like if your company did not exist. It’s a deliberate attempt to catch enterprising individuals who use corporate status to gain tax and NI advantages - so be careful - you should still aim to meet the tests for “self employment”.
Do everything you can to make it a contract for services.
If you struggle with this or are worried that you cannot do a lot of these things then take a look at the helpful information at IR35Calc.
If a particular client contract has more characteristics of employment and you can’t change this then make sure you put something aside for a potential tax bill for this work.
Some organisations offer you the chance to be part of an umbrella or managed service company. Be very careful with these as the Revenue are looking for ways of treating them as deemed employment as well.
Differentiating yourself
The tables below suggest some areas to pay attention to if you want to make sure that you distinguish yourself from the employee pool of your client. Remember though that this is not a guarantee. Revenue and Customs will look at the whole picture rather than taking a checklist approach.
The key issue is whether your contract (real or implied) with the customer is a contract of service (you are an employee in service to an employer) or a contract for services (you are a self-employed person rendering service to a client) and that is what these “tests” below relate to.
Remember, this is not a definitive list and not a guarantee but the more of them you comply with the more likely you are to avoid problems…
| Areas to think about | Contract For Services If… |
|---|---|
| Location: Can any of the work be performed away from the employer’s premises? | Work can often be carried out at locations of the contractor’s choice. |
| Equipment: How much of the equipment used belongs to the employer? | Using little of the employer’s equipment and some of contractor’s own. Possibly some of the contractor’s own handouts and demonstration materials. Use of own equipment to prepare reports. |
| Regular and repeated times of activity: Does the work take place at regular times and places? Are there standard hours of work? | Work is agreed on a one-off and irregular basis. |
| Terms & methods of payment: How is payment calculated? How are expenses recovered? | Preferably fixed fee specified service, not day rates, not hourly rates, and no retainer. Expenses are included on the invoice; preferably fixed figures are agreed, receipts should not be originals but copies can be submitted as a courtesy |
| Degree of Control: How much control is exercised? | No other duties beyond the contract can be assigned. Contractor should not be part of a team including employees. Employer has no right to control how the work is done. Contractor has no control over employer’s staff. Employer cannot move contractor to another task. |
| Decisions: Who decides whether or not to take the work? | The contractor decides, employer has no right to insist. |
| Substitutes: Is there a right to get someone else to do the job? | Contractor has the right. |
| Financial responsibilities and risks: Who takes the financial responsibility? | A fixed price contract, provision of equipment, accepting some expense and existence of insurance taken by the contractor. |
| Opportunity to profit from sound management: Does the contractor’s profit or loss depend on his or her capacity to reduce overheads and organise work effectively? | Separate accounting and payment of costs etc. by the contractor. |
| Part of the organisation: Can the contractor be regarded as a part of the employer’s organisation? | No responsibility for employer’s staff, no direct control by employer’s staff, not a member of an internal or mixed team. No use of internal claim forms etc. |
| Termination: Is termination on completion of task, or by notice? | Termination on completion of task, not by notice. |
| Employee benefits: Sick pay, pension, paid holidays. | Not provided |
| Contracts: Is the contract continuous or is there a separate contract for each activity? | A separate contract for each activity. |
| Exclusivity of service: Can the employer restrict the contractor from working for other clients? In general, employees work for a single employer. | There should be no such restriction. Has a number of clients and can choose whether to work with them or not. |
| VAT registration: Is the contractor VAT registered? | Contractor is VAT registered; whether or not they exceed the mandatory threshold. |
| Limited Company: Does the contractor have a Limited Company with a business organisation? | Business organisation with own accounting, office services etc., other clients, significant work done on own premises, has other staff or directors who do significant work, has own business cards and letterheads. |
| Insurance Cover: Does the contractor hold separate insurance cover? | Insurance cover, especially professional indemnity is held. |
| Intention: Is there any intention on the part of either party to enter into an employment contract? | No intention. |
Checklist for Employment Status
- I understand the difference between a contract of service and a contract for services (see below)
- I understand how my work and operations fall under the IR35 rules
“Contract Of Service” - more likely to be an employee
- I have to do the client work myself
- I’m told what to do, at what time, where, when and how to do it
- I work a set amount of hours
- I can be moved from task to task
- I’m paid by the hour, week or month
- I can earn overtime or bonus payments
“Contract For Services” - more likely not to be an employee
- I can hire someone to do the work or engage helpers at my own expense
- I risk my own money
- I provide the main items of equipment I need for the job
- I agree a fixed price regardless of the time to completion
- I decide what to do, how and when to do it and where to provide the services
- I regularly work for a number of different people
- I have to correct unsatisfactory work in my own time and at my own expense
If you are affected by IR35 or have heard about this but not quiet sure what it all is then you may find this site helpful. IR35Calc and it’s sister site ContractorCalculator are aimed at working contractors and feature advice, articles and forums where you can pick up a lot of free information.
The sites are funded by advertising so tend to be a bit visually crowded but there is a lot of useful information there.
