IR35 compliance

When completing the P35 Employer's Annual Return, companies and partnerships must consider whether they have supplied workers to provide personal services to their clients during the tax year. The P35 Checklist, using the 2003/04 wording, asks "Do the rules relating to services provided through an intermediary (sometimes known as IR35) apply to any work carried out by any worker listed on this return? If 'Yes', have you included a deemed payment, or any part of one, in the list on this form or on any Continuation Sheets?"

During an employer compliance review, the Inland Revenue officer may decide that it is necessary to approach a client of the service company to investigate the nature of the working relationship between the client and worker who was supplied by the service company. Before doing this, the officer will ask for the worker's permission to approach the client.

The Inland Revenue would prefer that consent be given for direct contact with the client in a manner that is mutually acceptable to the worker and client but, if consent is not forthcoming, the officer is nevertheless authorised to approach the client direct in order to obtain information about the day-to-day working arrangements of the worker.

Employers who engage the services of contractors from service companies are not responsible for any employment status issues arising from the engagement. However, they may expect to be approached by the Inland Revenue for information that will help the officer decide whether the service company has made correct status decisions and handled the worker's tax affairs appropriately.
(Source: www.inlandrevenue.gov.uk/ir35/faq_qanda/compliance_q6.htm )
...back to 9 January 2004

Personal services through intermediaries

The Finance Act 2003 has amended the IR35 legislation so that work performed personally for the client is brought into scope of the legislation, not just work performed for the client's business. (See newsletter of 18 July 2003) The corresponding change has now been made to the NICs legislation, with effect from 8 August 2003.
(Source: www.hmso.gov.uk/si/si2003/20031874.htm )
...back to 1 August 2003

IR35 and composite service companies

An article in the latest issue of the Revenue's Tax Bulletin clarifies the application of the IR35 legislation to composite service companies. Many service companies that fall within the special IR35 tax and NICs rules consist of only one person, i.e. the director, providing services under contracts made between the service company and the client.

In contrast, composite service companies take on many employees, again also to provide services under contracts between the company and its clients. The employees are paid a small wage, usually just above the national minimum wage. These are also normally shareholders and, as such, receive dividends that supplement, often substantially, their salary or wage. The dividends are commonly paid monthly, but sometimes are even paid weekly.

Some composite service companies have more than 20 such employees in order to avoid the "material interest" test. This brings into the scope of the IR35 rules workers who hold 5% of the share capital of the company. However, the Revenue's article points out that workers may receive dividends from a smaller shareholding but still come within the IR35 rules. They have only to receive payments and benefits from the service company that "can reasonably be taken to represent remuneration for services provided by the worker to the client".

The Revenue emphasised in the article that it is monitoring compliance with the service company legislation as part of its general programme for supporting voluntary compliance and tacking non-compliance. For more information see: www.inlandrevenue.gov.uk/bulletins/tb60.pdf .
Payroll Briefing 6 - 12 September 2002

Personal services through intermediaries

Various changes have been made to the "IR35" legislation with effect from 6 April 2002.

In calculating a worker's "attributable earnings", i.e. the total earnings in the tax year that must be subjected to Schedule E tax and Class 1 NICs, the following clarifications have been made by The Social Security Contributions (Intermediaries) (Amendment) Regulations 2002.

As directed by step 3 of the defined calculation process, any expenses incurred by the intermediary that would have enjoyed tax relief had the worker been an employee of the client are deducted from the total income from the contracts. The meaning of the term "expenses" has now been extended to include

• expenses that were incurred by the worker and reimbursed by the intermediary, including situations where the worker is a member of a partnership that is an intermediary
• an amount of mileage allowance tax relief to which a worker, or a worker who is a member of a partnership that is an intermediary, would have been entitled had the worker been an employee of the client and a vehicle provided by the intermediary had been treated as the worker's own vehicle.

Under the existing provisions of step 7 of the calculation process, the attributable earnings are further reduced by (1) the total of the remuneration paid to the worker that has already been subjected to tax and NICs and (2) the total value of benefits provided on which the employer is liable to pay Class 1A NICs. The meaning of the term "remuneration" has now been extended to include any mileage allowance payments and passenger payments that qualify for tax relief under the new provisions that take effect on 6 April 2002.

These new provisions have the effect of preventing such expenses and payments from being included in the worker's "deemed payment", on which tax and Class 1 NICs must be paid at the year-end.
Payroll Briefing 221 - 12 April 2002

Revenue wins IR35 judicial review

The Revenue's IR35 rules came into force on 6 April 2000 and the special year-end reporting arrangements apply during April 2001. An article on these rules appeared in issue 178 of Payroll Briefing and more detailed information is also included in Payroll Handbook, in the section "Personal Services Through Intermediaries".

In brief, an "intermediary" is a limited company or partnership, generally called a "service company", that is set up to supply one or more workers to perform services for clients. There are about 90,000 such service companies in the UK that have been set up by skilled workers in order to benefit from the more favourable tax regime available to limited companies. Some are "one-man" companies; others consist of many workers. Typically, an IT consultant sets up a service company with the aid of an accountant and is 'supplied' by the service company to perform work for one or a number of clients. The clients pay the service company's invoices and the worker, as a director of the service company, takes a small wage from the payments, at a level that requires little or no Class 1 NICs to be paid. The service company also pays corporation tax on the business profits, at a rate that is less than income tax. Whatever profits remain in the business at the year-end are taken as a dividend, on which income tax is due but no NICs. The Revenue estimates that, on annual earnings of £;50,000, the worker would pay around £;10,500 in tax and NICs under this arrangement, instead of £;17,500 if the work were performed as an employee.

There is nothing illegal about this arrangement and the Revenue's IR35 rules do nothing to make it illegal. The rules are aimed only at the situation where the service company is set up for the purpose of avoiding the payment of NICs. This occurs only where the nature of the services performed for clients by the worker would, if the service company did not exist, have to be treated by the client as employment. In such a situation, the client would have had to have paid the worker through the payroll, deducting PAYE tax and primary Class 1 NICs from payments to the worker and paying secondary Class 1 NICs.

To ensure that full Class 1 NICs are paid in such a situation, the IR35 rules require the service company to decide which contracts during the tax year are effectively "disguised employment" and, after an allowance for expenses, to determine the earnings from those contracts that have not been subjected to PAYE tax and Class 1 NICs. That amount is deemed to be paid to the worker on the last day of the tax year and, whether or not the worker actually takes the money as wages, the service company is obliged to subject that "deemed remuneration" to PAYE tax and Class 1 NICs. As the worker is a director, the NICs are calculated using an annual earnings period, with the result that a full year's Class 1 NICs are taken in one go. These final liabilities must be paid to the Collector by 19 April. Interest is charged if the payment is late.

The decision as to whether the work performed for any particular client would otherwise be employment has to be made by the service company, using the established employment status tests used to distinguish between employment and self-employment. This is a notoriously difficult task in the case of contractors and the Revenue arranged for decisions to be made in particular cases by a tax office in St. Austell, as long as copies of contracts were provided and enquiries could be made of the workers and clients in order to understand the working relationship in full.

To say that these rules have been controversial and unpopular is an understatement. In October 2000, a body representing many of these service companies, the Professional Contractors' Group (PCG), obtained agreement in the High Court for a judicial review of the statutory rules, on three grounds, namely that they constitute illegal state aid to companies that are not subject to the rules, that they impose a restriction on the free movement of consultants, and that they involve unreasonable confiscation of property under the European Human Rights Convention.

The Revenue and the PCG provided evidence for the review in January and the full hearings took place over five days in March. The decision, which was in the government's favour, was given by Mr. Justice Burton on 2 April. He upheld the government's right to set tax policy and told the PCG that they had failed to show that the legislation broke European law and contravened the Human Rights Convention. He also refused to give leave to appeal against his verdict.

Nevertheless, the judge criticised the Revenue on two counts, on the quality of their published guidance which, he said, 'has not always been clear and helpful', and on the manner in which some of their status decisions were being taken. The PCG are advising their members to appeal against any decisions made by the Revenue on their status where they believe that the decision:

• has not considered whether they are in business on their own account, by demonstrating that they have a history of working for a
number of clients
• has not considered whether, if the hypothetical employment contract envisaged by the IR35 legislation actually existed, the "mutuality
of obligation" test would apply, i.e. that the client, as employer, would not have been obliged to provide work and the worker, as
employee, would not have been obliged to perform the work
• has given greater weight to the absence of a right to provide a substitute worker than it deserves, given the complexity of the work
undertaken
• has given greater weight to the employer providing the tools of the job than is relevant in knowledge-based contract work
• has taken into consideration information that was not available to the worker, e.g. the actual contract between the service company
and the client (only likely where the service company has many workers)

The PCG's own comments on the judgement show that they accept that there are a number of circumstances in which it would be difficult for a worker to show anything other than employment. These include:

• service companies with many workers, where each worker has little involvement in the everyday affairs of the company, or in seeking
new contracts, or in controlling the company's bank accounts
• contracts for a year or more that are for support work rather than a specific task
• contracts that do not define specific tasks or that do not end when those specific tasks are completed
• the worker is mixed in with employees of the client, and doing very similar work.

The Revenue has made little comment about the decision other than to declare the government "glad that the High Court has confirmed that the IR35 legislation is not contrary to EC and Human Rights law, and that the uncertainty caused by this case can now come to an end. The IR35 legislation is the law of the land, as enacted by Parliament and upheld by the Court. Individuals affected by it will need to make sure they take the necessary actions to ensure they comply with their obligations under this law."

Information and advice is available from the IR35 helpline on 08453 033535 and on the Revenue's website at www.inlandrevenue.gov.uk/ir35/index.htm. - Payroll Briefing 200 - 27 April 2001