IR35

In April 2000, HMRC introduced rules which affect the way personal service companies (PSCs) operate, so as to remove opportunities for the avoidance of tax and national insurance contributions. The rules are not intended to prevent workers from providing their services through a PSC, but rather to discourage the practice of routing engagements through PSCs simply in order to achieve a more favourable tax and national insurance regime.

The legislation states that: ‘If through your company you are doing the sort of work for your (ultimate) client that would normally be undertaken by an employee working directly for that client, then 95% of the income (both fees and expenses) received by your company during the tax year, excluding VAT, must be paid in that tax year, as salary and employer’s national insurance contribution, to you the individual earning those fees.’

The IR35 legislation is only applicable in certain circumstances depending on an individual’s ‘employment status’, which in turn is determined by employment legislation.

HMRC has an IR35 web site, which is constantly updated, and in addition they have published an Employment Status Manual.

Identifying engagements where the IR35 rules will apply

The legislation applies to anyone supplying his or her services to clients through a PSC, and whose contract would have been a contract of employment with the client, if the worker had worked directly for the client instead of through the PSC. IR35 applies only if the contract provides for services to be carried out personally.

The rules apply in respect of each engagement, in the same way that the rules of self-employment apply to individuals operating without service companies. Note that the facts of the case will take precedence over careful drafting of contracts.

The ‘self-employment’ test

For income to be classed as non-IR35 income, you need to be genuinely self-employed. However, there is no statutory definition of ‘employment’ and the following is offered only as a guideline.

If you can answer ‘yes’ to most of the following questions, you are probably employed and therefore subject to IR35:

Do you yourself have to work rather than hire someone else to do it for you?
Can someone tell you at any time what to do or when and how to do it?
Are you paid by the hour/day/week/month?
Can you get overtime pay?
Do you work set hours, or a given number of hours a week or month?
Do you work at the premises of the person you work for, or at a place or places he or she decides?

If you can answer ‘yes’ to most of the following questions, it will usually mean you are self employed and therefore not subject to IR35:

Do you have the final say in how the business is run?
Do you risk your own money in the business?
Are you responsible for meeting the losses as well as taking the profits?
Do you provide the main items of equipment you need to do your job?
Are you free to hire other people on your own terms to do the work you have taken on?
Do you pay them out of your own income?
Do you have to correct unsatisfactory work in your own time and at your own expense?

Many workers will be able to answer ‘yes’ to questions in both sections. However, in addition to the above questions, HMRC will look at the degree of control you exercise and the basis on which you are paid and whether you can use substitute to do your work as well as the wording of contracts, and no doubt other factors, to determine your status. It has emphasised that in assessing your work it will take into account all the factors and will not rely on satisfying one aspect; for example, the wording of the contract.

An interim management assignment, almost by definition, will probably be regulated by IR35, whereas a consultancy assignment will probably not be. It may be that some assignments come within IR35 and other assignments do not, in which case you will have two pools of money and you will have to apply the rules to one pool and not to the other.

For each of your contracts, we recommend that you obtain an independent review to establish its IR35 status.

Calculation of salary under IR35 rules

IR35 states that: ‘If through your company you are doing the sort of work for your (ultimate) client that would normally be undertaken by an employee working directly for that client, then 95% of the income (both fees and expenses) received by your company during the tax year, excluding VAT, must be paid in that tax year, as salary and employer’s national insurance contribution, to you the individual earning those fees.’ The calculation must be based on your total income (fees and expenses) and from this 95% figure certain permissible expenses may be deducted. The resulting figure is the total of salary and employer’s national insurance contribution for the period.

Expenses

To arrive at the amount that must be devoted to paying your salary, you deduct the following expenses from the money received in respect of relevant engagements:

5% of both the fees received for the relevant contracts and the expenses you have charged your client in relation to these fees. This is intended to cover the various miscellaneous expenses of running your company, including accountancy fees, training and the cost of seeking contracts.
Any employer pension contributions made to an approved scheme which are allowable under normal rules.
Professional indemnity insurance premiums.
Capital allowances in respect of computer equipment purchased by your company. Although you may not claim a deduction for the cost of purchasing your own equipment if your client provides you with all the equipment that you require (even if your contract states that you should own your own equipment), expenditure on computers and computer software up to £50,000 per year qualifies for full capital allowances. We therefore take the view that you may claim the entire cost of computer equipment as a deduction in the IR35 calculation.
Professional subscriptions to, and levies of, societies where related to the engagement. This does not include accountancy fees.
Certain benefits in kind (e.g. private medical insurance), on which employer’s national insurance is payable.
Expenses currently allowed under the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) expenses rule, such as business travel and subsistence costs including accommodation and meals when working away from home. Such expenses must be expended wholly, exclusively and necessarily in the performance of the duties of the relevant engagement

Note 1 Travel expenses: If you are continuously employed by your PSC and undertake contracts for clients of your company in different places, provided that each of your assignments last for no more that 24 months, your client’s premises are treated as temporary places of work and you may claim a deduction for the cost of travel to and from your client’s premises. If an assignment lasts for more than 24 months, but you do not expect to work at your client’s premises for more than 40% of the time, you may also claim the cost of travel to and from your client’s premises. You may claim these travel expenses both in the IR35 calculation and as an expense for corporation tax purposes. However, if your contract is initially for a period of less than 24 months but is subsequently extended beyond 24 months, you should cease to claim travel expenses from the time that you learn that the contract is to be extended.

Note 2 Use of home as office: Because of the difficulty in calculating the exact costs of electricity, water and gas used for business purposes, HMRC permits a claim of £3 per week for use of your home. This can be claimed without need for receipts and proof of substantive duties.

Remember that accountancy fees and travel expenses not specifically related to the paying client are covered by the 5% allowance and cannot be treated as a deduction. The cost of training is also specifically excluded from the formula.