Legislation Guide – IR35
The IR35 or Intermediaries Legislation was introduced in 1999 and aimed to distinguish the differences between an employee and a contractor. This meant people could not be paid through a Limited Company if they were a ‘disguised employee’.
Background to IR35 legislation
IR35 is the bane of many a contractor’s life thanks to its clear as mud regulations and it being a common buzz word amongst agencies, providers and advisors. IR35 needn’t be either scary or confusing, and we’re going to explain it and how it impacts on you in a very simple way.
During the period leading up to the late 1990’s, some tax savvy bods set a trend of people leaving permanent employment and the next day doing the exact same job in the exact same way for the exact same company as a contractor, but not paying the exact same levels of income tax, which became known as the “Friday to Monday” scenario.
The government became a bit concerned about the lost taxes caused by this trend, and of contractors setting up their own company, or joining a company with other contractors simply to receive their income in a more tax efficient way. They decided that they needed to introduce some rules to control this pattern, so that the only people who could take advantage of the tax benefits of operation like this were those people who were genuinely working in a self-employed way.
What is IR35?
So along came IR35. Its proper name is the Intermediaries Legislation, and it was announced by Gordon Brown, the Chancellor of the Exchequer at the time (1999). For those of you who are intrigued by the term IR35, it simply means that it was the 35th statement of the Inland Revenue in that year (see- this really is simple stuff!) Mr Brown announced that he was going to tackle the issue by introducing a series of laws to ensure that anyone who was operating through a limited company but was actually a ‘disguised employee’ of their client paid income tax and national insurance on the full amount, rather than receiving their income in other ways, usually by means of company profits which do not attract a National Insurance Contribution. The government claimed that they would collect £220 million each year in National Insurance Contributions that otherwise would not have been paid, and that their coffers would be swelling as a result.
So, what does this actually mean to you and us? And what’s happened since? Read on …
Firstly, let’s get the jargon right. A contractor who is a disguised employee would be ‘inside IR35′ – yep, you guessed it, caught by the legislation. A contractor who is not acting in the same way as an employee is ‘outside IR35’ and therefore not caught by the legislation.
IR35 in practice is simply the distinction between an employee and someone who is not. Yep, it’s that simple. The government didn’t have much luck with the legislation, partly because it’s so difficult to understand. So, in 2003 along came IR56 (bet you can guess why it’s got the name. Not all that imaginative are they). This helped clarify things for us and we now have some clear indications as to what situations mean.
Of course, it’s not always as easy as 1 + 1 equalling 2. For example, different circumstances apply to different occupations, and sometimes it’s not possible for a company to allow a contractor to remain completely independent (this could be for security reasons, for example). Also, for many years, it was considered that as long as the contract in place between the company and the client was compliant with the legislation that would be enough. But case law (which is the stuff that cements the rules), especially the Dragonfly Case, has shown us that the contract is only one part of the equation, and actually you need to be just as aware of your actual working circumstances, as well as the stuff on paper. So it’s important to have a well written contract that’s been reviewed by experts, as well as to have those experts (yep, that’s us) review your circumstances and how you work on a contract. It’s important to remember too that each contract has to be reviewed separately: it’s possible to have different outcomes for different contracts.
HMRC have issued their own guidance on key employment status test, if you’d life to take it from the horse’s mouth, take a look at their website here.
IR35 test – a practical example
So, let’s talk about the key tests that indicate whether someone is inside IR35 or not. First and foremost, we need to consider what your working arrangements are. To show us key differences, we’ll do a little role-play. You’re a mortgage broker and you need a new IT network in your numerous offices for your administration staff. Meet Daniel. Dan is an IT Contractor, and specialises in fitting IT networks. We’re going to look at the relationship between you and Dan, and how that impacts on whether Dan is inside or outside IR35.
You’ve looked at what you need, and decided what needs to be done in your offices. You’ve looked at various options, and have decided that you need a contractor who has specific experience, and Dan has this. You have seen that he runs a legitimate business and you’ve checked that he has the all-important business insurances in place, just in case something goes wrong. You’ve agreed a price for the services, and agreed the specifics of his assignment, as well as the required completion date or duration required. So both you and Dan understand the project, and have agreed the key elements.
Now, you’re an expert in your field of financial advice, but you haven’t got the first idea about setting up IT networks. That’s why you’ve hired an expert. You’ve told Dan clearly what needs to be done, but as the expert, Dan decides the best way to do it. You don’t tell Dan what time he should arrive on a particular day, unless it severely impacts your business. You don’t tell Dan where he should be, it may be that he works on the network from his own offices, or it may be that he’s at your premises – which at times he will have to be. You don’t tell him how to design a network, and you don’t tell him where to lay cables. This shows that Dan has control over how he completes the services, and doesn’t have to comply solely with your requests, in the way that an employee would have to.
If Dan makes a mistake, like for example putting the network in the wrong office or fitting a network that doesn’t satisfy the requirements you provided to Dan at the start of the project, as a professional Dan would need to rectify any mistakes at his own time and cost. He is responsible for his own finances, and if he completed the job ahead of schedule, he’d be able to profit from that too, and likewise, if anything went wrong with your business that meant you didn’t pay his invoices, he could make a loss. You’ve also already checked that Dan has insurances, so that on the off chance that anything goes wrong, you can claim for any losses. All of this shows that Dan can benefit financially from his own work, and likewise, if anything goes wrong, he could lose out too, he has risk – these are factors that would not be applicable to an employee.
We know that you’ve taken Dan on based on his specific credentials and him being qualified for your project. But what if Dan sent Dom instead? As a professional contractor, it wouldn’t make any difference to you if it wasn’t Dan specifically, but someone else, with just the same credentials. You’re entitled to be sure that Dom is just as suitably qualified, but beyond that, there is no agreement for personal services from Dan, just the completion of the services. Unlike an employment relationship, you haven’t hired a person specifically, but a qualified professional. There is a right for the initially named person to be substituted for another.
Now, if Dan does a good job, you may decide to offer him further projects, as and when they come up. And Dan might decide to offer his services again. But, if you decide not to, then you’ll never see Dan or his team again. And even if you do offer further projects, Dan has no obligation to accept them. Unlike employment relationships, there are no obligations between the parties to offer or accept projects.
Let’s take a look at the key elements above which make it clear that your relationship with Dan is not one of ‘disguised employment’:
- There is a defined project with specifically agreed terms in place, all of which have been discussed and agreed in advance of the project starting
- There is risk for both parties: if Dan doesn’t complete the services, he could lose money and reputation, where as if he completes early, he has the opportunity to benefit
- Dan has taken out appropriate business insurances at his own cost to protect himself and his customers
- Dan has invested in his own business by providing his own equipment where necessary
- Dan has independence and control as to how, when and where he completes the projects, within the scope of the deliverables you’ve already agreed
- Dan is able to substitute himself for another suitably qualified person at his discretion
- There is no mutual obligations between you and Dan to offer or accept any further projects
Having reviewed the circumstances of your working practices, it’s just as important to consider your contract. It’s important that there is a contract for services in place with your agency or end client. Another bit of jargon for you – a contract for services is a contract where the client has a requirement for services to be completed, and the contract that is in place is for those services. The opposite of this is a contract of service. Not much difference in the name, but a huge difference in the contract. A contract of service is where the client wants a specific person rather than services, and engages that person individually. That’s employment, so if you’re looking to be outside IR35, a contract for services is the forward.
All of the points that we’ve covered in our description of the relationship between you and Dan need to be included in the contract between the limited company and agency/client. At the cps group, if you take up a service which needs to be mindful of IR35, then our experts will complete a full contract review for you if you’d like our assistance. Because we’re nice like that!