IR35

WHAT IS IR35?

IR35 is the most important, and controversial, piece of legislation to affect limited company contractors. It was first introduced in 2000 as a means of preventing what is known as false self-employment. This is where a person that would otherwise be employed sets up a limited company to supply their services and enjoys the tax advantages that are associated with self-employment. IR35 therefore seeks to tax individuals that operate like this in the same way as permanent employees.

 

How is IR35 status determined?

IR35 status is based on whether an individual would be employed or self-employed in the absence of the limited company. Neither employment or self-employment are defined in legislation, case law judgements are therefore used to determine an individual’s employment status. The seminal case on employment status, still used today, is Ready Mixed Concrete (1968). This case determined that for an engagement to be one of employment, each of the following three factors must be present:

 

    • Personal Service
    • Control
    • Mutuality of Obligation.

 

Each of these factors is described below, with comparisons provided related to our own business. We will compare what we would expect from an employee that we could take-on to do accountancy work to a business-to-business relationship that we enter into with a builder if we decided to build an office. Clearly, we are not builders and know nothing about building (as possibly about to be demonstrated) so would engage with an external supplier for such a one-off project.

INTRODUCTORY OFFER: NO CATCH-UP FEES

IR35 is the most important, and controversial, piece of legislation to affect limited company contractors. It was first introduced in 2000 as a means of preventing what is known as false self-employment. This is where a person that would otherwise be employed sets up a limited company to supply their services and enjoys the tax advantages that are associated with self-employment. IR35 therefore seeks to tax individuals that operate like this in the same way as permanent employees.

Each of these factors are detailed below with comparisons.

1. Personal Service

Personal Service is about whether the engager requires work to be completed by the specific worker (i.e. his/her personal service) or if they would accept a substitute sent in their place.

Example:

If we were to employ a new accountant then we would do so based on the skills, qualification and experience of the individual that we sought to employ. We would interview said individual and, should they be successful, we would expect that same person to turn up each day for work. We would not be pleased if they send another person in their place.

If we engaged with a builder, provided that the finished building to the required level of quality (defined up front) then we would not be concerned with who laid the bricks to make the building.

2. Control

This is about whether the worker has autonomy to use his/her own methods to complete the work, or if the tasks must be completed using methods prescribed by the engager.

Example:

At Alchemy Accountancy, if we take on a new accountant then we would expect him/her to follow the processes that we prescribe to them to complete any work that is required. We set the processes as a means of ensuring a task is completed to the quality that we advertise.

In terms of our (hypothetical) building, we may tell the builders where to put the new office, how big it is to be and how many windows it must have; however, we would not be concerned with how the builder put one brick on top of another or what end of the brick had cement applied.

Speak to an accountant today

3. Mutuality of Obligation

Mutuality of Obligation is about whether the engager is obliged to supply work to the worker, and if the worker is obliged to accept any work that is offered.

Example:

At Alchemy Accountancy, if we take on an employee we will be required to provide him/her with work on an ongoing basis and if no work is available then he/she will continue to be paid. Conversely the employee would be required to accept any work that we ask him/her to complete. Each party, the employer and employee, has mutual obligations to each other.

 

If we use the services of a builder, we would not be obliged to ask them to build something else when they have finished constructing the office. Likewise, if we did offer something else for them to build they would not be required to accept it.

Implications

When a limited company is used as a vehicle to supply services, if IR35 does not apply then a fee is paid to the company in exchange for the services; hopefully giving rise to a profit after expenses have been considered. How and when the profit is then distributed to shareholders is the decision of the shareholders, and they may choose to distribute it in a way that minimises the amount of tax paid, such as by paying a small salary and paying a dividend on the surplus or deferring payment to a different tax year.

If IR35 applies, then the receipt of fees for services rendered must be paid as a salary to the person that provided the service, and it must be paid in the tax year in which the cash is received by the company. This means that employment taxes are applied to all company income and (generally) expenses cannot be deducted – this means that the company will not make a profit that can be distributed in a tax efficient way.

IR35 Changes in Public Sector – 2017 Update

In the 2016 Budget, the chancellor, Phillip Hammond, announced his intent to consult on some changes to the way that IR35 status is determined for those that are involved in the supply of services to a Public Sector Body.

The proposed changes put the determination of IR35 status into the hands of the Public-Sector Body, rather than the hands of the contractor, as it was previously. The new policy was confirmed in the November 2016 Autumn Statement, and were more draconian than had been anticipated. In addition to moving status determination to the hands of the engager, the 5% allowance was also removed and employment taxes withheld by the party closest to the worker (usually a recruitment agent) and a net payment made to the PSC.

FREE BUSINESS CONSULTATION