What is IR35?

At the time of the budget in March 1999 the Inland Revenue issued a press release known as IR35. This was notification of a proposal to prevent tax avoidance in the provision of personal services. The example given was that of an employee who leaves employment on a Friday and returns to work on the Monday as an Independent Consultant through an Intermediary Company. However it has since become clear that this was little more than a smokescreen for the real intended targets of the legislation. The intended target was all Independent Contractors and especially those in the IT and Engineering industries. The legislation is an attempt to force all Contractors who work for one client at a time to pay tax as if they were employees of the client. However, the legislation is even broader than this and will affect anyone working for a client under terms, which look like employment. Unfortunately the Revenues idea of employment does not fit with the modern working practices in the knowledge based sector.

The mechanism to be used for this is very complex but essentially it boils down to the following. The Government and the Inland Revenue believe that if you are paid hourly/daily and attend the clients site to do your work then you are in fact a "disguised employee" of the client and not a "real business" or even a "self-employed" Consultant/Contractor. We do not believe that this view is supported by Case Law.

If you are caught by these vague rules, then your company’s income will be deemed to be your salary, subject to a deduction of 5% of the income to cover the running expenses of the Company. In addition any expenses which would be allowable under schedule ‘E’ will also be allowable. For the average Consultant/Contractor the schedule E expenses will be travel expenses and pension scheme contributions, but all the other costs of running your business, such as the costs of admin or support staff, will not be allowed. No allowance will be made for investment in your business either by way of training or as reinvestment to fund expansion plans.

As a result you will be paying proportionately more tax than any other employee in the country and substantially more than your larger competitors, whom the government believes are "real businesses". This is because you will be paying PAYE and employer’s and employee’s National Insurance on virtually all of your company’s gross income.

Isn't this about fairness?

No it most certainly isn’t! The government has repeatedly stated that Contractors pay proportionately less tax and NI than Nurses and that this is to redress the balance. However, they conveniently ignore the fact that contractors are not employees of their clients and don’t get any of the benefits normally associated with employment. Contractors have to fund their own sick pay, holiday pay, company pension, training, and have a reduced ability to claim unemployment benefit.

How can I avoid IR35?

In technical terms, you must ensure that your contract is a contract for services and not a contract of services. (PCG members have access to our example contracts.) Having a contract for services is the first line of defence against this attack on your business. But it must accurately reflect the real working relationship with your client. You must ensure that your "business credentials" are beyond reproach. This means you should try to find other clients in parallel with your main client, make substantial investment in your business and have a "business organisation" (Computer/ Fax/ Phone line etc.) Unfortunately Contractors have not had to defend their "self-employed" status in the courts for at least 20 years and so much of the Case Law is not directly applicable to our businesses or to the modern age of the Internet and the sale of knowledge in the economy. This will change over time and (In the PCG's opinion) things will become easier once cases start to come to court.

Will the PCG contract get me past IR35?

The PCG contract is a template into which you must add the details of the actual working relationship between you and the client. Our advice is that this contract would fall outside IR35, provided the actual working relationship does not resemble employment, and that it is accurately reflected in the contract. However no one can be certain at the present time how the Inland Revenue or the courts will interpret this legislation. We will need status cases to be taken before the courts before a definitive answer can be given."

Our considered opinion is that the scope for this is limited. The only way appears to be to show that you are "self employed" and therefore in business on your own account. To do this you must pass the so called "self-employment tests". Unfortunately these tests not defined in statute but are as they are just a distillation of case law, which makes it difficult to determine your own status without professional advice.

This is largely up to the individual businesses, but our current advice is not to send contracts to the Revenue for review. Whether you pass or fail the IR 35 tests depends not only on your contract but also your whole business organisation and any other work you may have. If the Revenue fails your main contract it will make it even harder to persuade them in future that, taking the whole picture, you fall outside IR 35. Even if they pass your contract they are always able to reconsider their position in future. Hence there appears to be a great deal of downside and little upside in getting your contract reviewed.

Also our experience to date has been that the Revenue are being overly selective with the case law and are failing contracts that we believe are outside the scope of this legislation. In our opinion it is better to get professional advice from a legal expert.

What can I do to mitigate the effects of IR35?

If you cannot pass the self-employment tests for a particular contract you must get your company expenses down below 5% of turnover to remain solvent. Expenses like training can be paid out of your personal income but bills for the preparation of company accounts, payments to Companies House, employers liability insurance and the like must come out of the 5%. From a taxation point of view you can defer some of the worst effects on your income by paying more into your pension scheme but this will not help if you are struggling to pay your mortgage! Since Schedule E expenses are allowable (including travel to and from the client site under the two-year rule) you must make sure that you maximise these. Speak to your accountant to be sure that you are claiming all that you are entitled to.

My agent says he can't change my Terms and Conditions because that would be illegal?

Not True! The only way this could possibly be illegal is if the contract is a sham. Provided the T&C;'s accurately reflect the working arrangements then this is not a possibility. You are entitled to renegotiate your terms and conditions and any sensible business does exactly this in the light of new legislation. In the PCG's experience, many agency contracts do not reflect the real picture as they currently stand. Many make the contractor look more like an employee than an Independent and do not accurately reflect the Contractor/Client relationship.

I am working directly for a client. Why are they are now trying to force me to work through an agency?

The PCG has heard of cases where the Agency has "whispered in the Clients ear" and informed them that they could be liable for the Contractor's taxes under IR35. We believe this is an attempt to get a cut of your rate to which they are not entitled. IR35 explicitly exempts the Clients from any responsibility for the Contractor's taxes. In other cases we have heard that some Agencies are using scare tactics regarding employment rights claims as a lever in this respect. The PCG view is that the employment benefits risk is real but that the Agencies probably offer little protection in this respect. Some case law suggests that the Client can be held to be the employer regardless of the presence of an Agent in the Chain. Only a correctly worded contract and a true business to business relationship can fully protect the client from such claims.

What can I do about IR35?

The best direct action you can take is lobbying. Lobbying is not just about writing to your MP or Government Ministers, it is about informing and educating your entire circle of contacts and the Press. Write to your MP. Write a letter to your local paper and to the nationals. If you are in London go to the Houses of parliament and ask for a green card to see your MP. Alternatively make an appointment to see him/her at the local constituency "Surgery" and explain the effects this legislation is going to have on your life and business.

Can I use any clever schemes to avoid IR35?

If you are prepared to give up your independence and become an employee of an umbrella company then there ways of being remunerated and rewarded (deferred salary, share options, employee benefit trusts etc) which can help to reduce the overall impact of the tax changes. However these schemes depend a great deal on the trust you have that the scheme managers will operate the company correctly and safeguard the funds they hold.

There are also schemes that usually involve offshore arrangements. We haven’ t seen one yet that we believe to be watertight. Few offer any guarantees against future challenges by the Revenue and, invariably it will be the contractor who suffers if the arrangements are challenged by the Revenue. . There are also rules about transactions performed solely for the avoidance of tax that could allow the Revenue to disregard the transaction. Most Schemes would appear to fall foul of these. The use of Composite Umbrella companies, where the individual shareholding is less than 5%, also appear to fall foul of the legislation if the contractor is receiving most of their income in a form not subject to PAYE or NI

What sort of clauses do I need in my contract?

The genuine right of substitution is the most powerful clause you can have in your contract. The less restraints that are placed on this right the better. The contract should show that there is no Mutuality of Obligation in the relationship. This means that you have no obligation to accept further work from the client and he has no obligation to offer it. If possible, the contract should be project or task based rather than for a fixed period. If you can get the work on a fixed price basis (difficult in the knowledge-based sector) then this should put you firmly outside the rules. The contract should accurately reflect the amount of financial risk that you undertake in performing the services. You need professional advice on your contracts to minimise your risk of a big tax bill in later years. The PCG have an example contract for members that will greatly aid your claim to self-employed status.