IR35 is the generic name given to anti avoidance legislation introduced by the Government to counter “abuse” of PSCs. The name stems from a press release issued in the April 1999 budget, and which applied from 5 April 2000 onwards. From April 2017 there is an extension and modification of IR35 for Public Sector contracts. It is proposed these apply to Private Sector contracts from April 2020.
The Basic Legislation
The legislation is contained in Schedule 12 Finance Act 2000. The basic legislation states:
(1) This Schedule applies where-
(a) an individual (“the worker”) personally performs, or is under an obligation personally to perform, services for the purposes of a business carried on by another person (“the client”),
(b) the services are provided not under a contract directly between the client and the worker but under arrangements involving a third party (“the intermediary”), and
(c) the circumstances are such that, if the services were provided under a contract directly between the client and the worker, the worker would be regarded for income tax purposes as an employee of the client.
(2) In sub-paragraph (1)(a) “business” includes any activity carried on-
(a) by a government or public or local authority (in the United Kingdom or elsewhere), or
(b) by a body corporate, unincorporated body or partnership.
(3) The reference in sub-paragraph (1)(b) to a “third party” includes a partnership or unincorporated body of which the worker is a member.
(4) The circumstances referred to in sub-paragraph (1)(c) include the terms on which the services are provided, having regard to the terms of the contracts forming part of the arrangements under which the services are provided.
(5) The fact that the worker holds an office with the client does not affect the application of this Schedule.
The legislation then goes on in some detail to set out the impact of this, block loopholes and prescribe remedies where the rules are not adhered to.
The legislation for National Insurance is located elsewhere but is to all intents and purposes a replica of the Schedule 12 provisions.
In essence IR35 applies where a contractor works on a contract in such a manner that they are a “disguised employee” – that is to say that if the PSC intermediary, and any other intermediaries, was stripped away would the contract be one of employment (IR35 fail) or one of self employment (IR35 pass).
The IR35 legislation itself may conveniently be broken down into three parts:
- The circumstances in which IR35 applies (broadly as set out above)
- The minimum salary requirement where IR35 applies
- The impact if the minimum salary is not paid
Circumstances in which IR35 applies
IR35 applies where a contract is one of “disguised employment”. That is to say if the PSC was stripped away, along with any other intermediary, eg the agency, would the contract be one of employment or self employment?
Unfortunately there is no statutory test for employment v self employment, but there is a lot of case law and practice to assist. The case law and practice is known as the “status tests” or “badges of trade” – this whole area of tax law is known as “status” and is practised in HMRC by “status officers”.
Our guidance on Status Checklist, looks at status in more detail.
It should be noted that the tests used are the same ones which apply in any status decision, and therefore the same criteria apply whether you are a sole trader, partnership or limited company. The only significant difference is where the risk sits:
- Working as a sole trader or in a partnership – risk with engager
- Working in a PSC outside Public Sector – risk is with PSC (and by extension possibly the individual contractor) – it is proposed this changes to the engager from April 2020
- Working as a PSC in the Public Sector – risk is with the person paying your company, the engager. However be aware of tax clawback clauses in contracts.
IR35 applies whether an agent is involved or not (although arguably direct contracts are more likely to pass IR35). IR35 also applies if you are not a director of your company or a major shareholder. Because the legislation has a catch all application to monies which “can reasonably be taken to represent remuneration for services provided by the worker to the client” (FA2000 Sch 12 S3 (1b ii).
IR35 applies to contracts or, if it is easier to conceptualise, engagements. It does not apply to all of your income en block – i.e. each contract/engagement must be considered separately and they are not tainted by previous passes or fails. The exception to this is that a history of strong outside of IR35 contracts can cover a short weak contract which would otherwise fail.It is the responsibility of the contractor to consider each contract as regards whether IR35 applies. Several organisations, including ourselves, offer contract review services to help you make an informed decision. HMRC have a contract review service but industry sources – and we concur – suggest that this service is not used as it is neither comprehensive nor unbiased.
Minimum salary requirement where IR35 applies
Where a contract is caught by IR35 a minimum salary requirement is created.
The effect of this minimum salary is:
- NI (employers and employees) is due on the income whereas if it was declared as a dividend it would be NI free
- The minimum salary has to be streamed to the contractor rather than to a spouse, with a possibility of wasting spouse allowances
- Expense offsets are restricted
The minimum salary calculation is:
- Income from contract caught by IR35
- Less direct contract expenses (tools, protective clothing, etc, which relate to this contract specifically)
NB from 6 April 2016, Travel and Subsistence is barred from being claimed.
- Less professional insurances (public liability, professional indemnity)
- Less pension contributions
- Less 5% of IR35 caught income as an allowance towards overheads/company running costs (not available for Public Sector Contracts)
- Equals figure to which IR35 applies
- The figure at (6) is then grossed down to take account of employers NI contributions. The current (16/17 tax rates) employers NI rate is 13.8%, so simply put (8) is (6) divided by 113.8%. However there is a £156 (16/17 Tax rates) p/w exemption from employers NI so this needs to be factored in where relevant
- The result – is such a figure that when employers NI is added on, comes back to (6).
The codification of this process into legislation is quite tortuous, and has been supplemented by various concessions and supplementary guidance notes. It becomes easier to understand with use, and any contractor who has an element of income caught by IR35 is advised to seek professional advice regarding calculating minimum salary levels.
The impact if the minimum salary is not paid
If a contract is caught by IR35 then matters are made considerably simpler by applying a minimum salary as above.
However the IR35 legislation goes into some depth about what happens where the minimum salary is not paid. The minimum salary is calculated, less any salary actually paid, and becomes a deemed salary, treated as paid on the last day of the tax year. Tax and NI is due on this under normal PAYE rules, but relief is granted against tax on dividends paid to the contractor from the IR35 income stream.
These rules are complicated and fairly indiscriminate in their application, particularly as regards how tax and NI on a deemed payment is relieved against dividends. It is strongly recommended that a realistic stance be taken on contracts IR35 status, and where IR35 applies that the minimum salary is paid as a matter of course rather than rely on these provisions.
IR35 is policed by HMRC as part of their PAYE//NI compliance procedures. In the first instance IR35 status is considered as part of a PAYE inspection (known these days as employer compliance reviews). Of course there is a element of risk profiling.
The status rules which drive IR35 (see next section) are well known and accountants are used to working with them – critically they are imprecise and open to much interpretation as they are case law based rather than statute based. Therefore there is opportunity to argue points with HMRC, however recently HMRC seem to be taking weak cases to Tribunal and loosing as much as they are winning – its hard to fathom their litigation strategy.
Situations of negligence – treating a contract which is clearly caught by IR35 as being outside of IR35 – are difficult to defend.
By contrast grey areas – where most IR35 disputes will fall – can be defended, or at the very least often negotiated to a settlement with HMRC.
At the outset, if HMRC request a review, then the contractor should obtain professional assistance regarding HMRCs information powers, strength of contracts, avoiding obvious pitfalls and similar.
To operate outside of IR35 successfully it is vital that the contract which you have for any engagement is “IR35 friendly” – for more information on this see the separate section “IR35 – Getting the Contract Right”.
However actual IR35 status is determined by the so called Notional Contract, which is the contract between the worker and end client if all intermediaries are removed. The actual contractual chain is likely to be:
- Worker > PSC > Agent > Client (agency based contract); or
- Worker > PSC > Client (direct contract)
However for IR35 the Notional Contract needs to be considered which is:
- Worker > Client
- Evidence from the PSC > Agent (lower contract) or PSC > client (pepper contract) contracts will be relevant but not determinative.
In any review HMRC will always try to look at the Agent > Client contract (so called upper contract), as quite often IR35 friendly points in the PSC > Agent contract (so called lower contract) are not carried forward here. From this evidence HMRC endeavour to construct the Notional Contract; there is no legislation in place concerning the construction of Notional Contracts and robust professional advice is required to counter HMRC cherry picking clauses to suit their own needs.
It is therefore important to either have sight of the agent to end client contract, or to have a confirmation from the agent that all material points from the PSC to agent client are mirrored in the agent to end client contract.
Public Sector Contracts and IR35 Reform
The rules above are modified for Public Sector Contracts from April 2017, see our separate guide
It is proposed the Public Sector rules operate in the Private Sector from April 2020.
There are other IR35 news stories and comment on our site: see them all here
- Tax cases and CEST 20/01/2020
- ACCA on IR35 2020 changes 25/09/2019
- IR35 Private Sector Changes 2020 – Draft Legislation First Thoughts 19/07/2019
- Off-payroll working rules (IR35 reform) 29/04/2019
- IR35 – Recent high profile cases – what can be learnt 26/03/2019
- Deemed payment and business expenses in the public sector 10/01/2019
- Off payroll rules set to target the private sector 05/12/2018
- Extension of Reverse IR35 Compliance to Private Sector from April 2020 07/11/2018
- IR35 extended to the private sector 31/10/2018
- Autumn Budget 2018 – Our Summary 30/10/2018
- Accounting and tax treatment of IR35 deductions in the public sector 30/08/2018
- Another HMRC IR35 defeat 11/06/2018
- HMRC Private Sector IR35 Reform Open Consultation 18/05/2018
- HMRC lose another IR35 case 18/05/2018
- HMRC loose IR35 case on control 08/05/2018
- Spring Statement 2018 13/03/2018
- First IR35 case in a while – Ackroyd v HMRC 22/02/2018
- New consultation on IR35 rules 27/11/2017
- Employed or self-employed? 15/03/2017
- Spring Budget 2017 – First Impressions 08/03/2017
- HMRC release new Employment Status Indicator Tool 02/03/2017
- Public Sector IR35 changes – Examples 11/02/2017
- Public Sector IR35 changes 07/02/2017
- IR35 Public Sector Reforms and the Autumn Statement 06/12/2016
- IR 35 – big changes for public sector bodies 07/10/2016
- Spring Budget: IR35 – the end of the flexible workforce 18/03/2016
- Spring 2016 Budget and Technical Briefing 16/03/2016
- IR35 changes on hold 17/12/2015
- Autumn Statement 25/11/2015
- Is fundamental reform of IR35 on the horizon? HMRC consultation 03/08/2015
- Budget 2015 18/03/2015
- Scare stories around Intermediary Reporting Rules 06/03/2015
- Taxwise on IR35 10/02/2015
- HMRC IR35 forum minutes 25/09/2014
- HMRC new IR35 guidance 20/06/2014
- Lords Select Committee on PSCs 10/06/2014
- HMRC and Personal Service Obligations (updated) 11/12/2013
- HMRC IR35 stats 11/12/2013
- HMRC and Personal Service Obligations 10/12/2013
- Autumn Statement & IR35 05/12/2013
- Dividend Levels and IR35 Risk 04/12/2013
- PA Holdings – appeal withdrawn 12/04/2013
- HMRC guidance on RTI and IR35 09/04/2013
- IR35 and office holders – Finance Act 2013 04/04/2013
- Budget 2013 20/03/2013
- IR35 Forum Minutes and Employers Bulletin 18/02/2013
- Autumn Statement 05/12/2012
- IR35 and Public Sector Contracts (redux 1) 16/10/2012
- New IR35 business entity guidance on our web site 04/10/2012
- IR35 and Public Sector Contracts 04/10/2012
- IR35 stats 01/10/2012
- New Guidance: Loans between a Company and its Directors / Shareholders 12/09/2012
- Dividend administration guidance 03/09/2012
- IR35 and Personal Liability – can HMRC proceed against an individual? 21/08/2012
- IR35 compliance checks to increase? 14/08/2012
- The P35 question on service companies – revisited 14/08/2012
- Closing down your company: a cautionary tale 09/07/2012
- Service Companies and the P35 question 29/05/2012
- IR35 and Controlling Persons 23/05/2012
- New HMRC IR35 guidance (updated: 10 May 2012 – 14:15) 10/05/2012
- IR35 and the budget 22/03/2012
- Pension capping: 2011-12 revised limits 14/12/2011
- Primary Path 16/08/2011
- LATEST EMPLOYMENT TRIBUNAL RULING 02/08/2011
- Update on a recent IR35 case 11/07/2011
- ECR Consulting: IR35 Hypothetical Contracts 28/06/2011
- IR35 and the Budget 24/03/2011
- Budget / IR35 22/06/2010
- June 2010, "emergency’ budget 22/06/2010
- Key points from Coalition Joint Programme 20/05/2010
- Tories to abolish IR35 09/02/2010
- IR35 Contract Reviews 07/10/2009
- Dragonfly 10/11/2008
- HMRC Service Company Definition 12/09/2008