14 June 2016
Inland Revenue press release number 35 (the 35th of 1999) is entitled Countering Avoidance in the Provision of Personal Services and was introduced to counter tax avoidance by the use of so-called personal service companies. The aim was to prevent workers from setting up limited companies to provide services to their ‘employers’ in which they would work effectively as employees, thus enabling them to use dividends and expense claims to save tax and National Insurance (NI). The measure came into effect in April 2000 and allowed HMRC to ‘look through’ the contractual arrangement between the worker’s company and the client company and to formulate a ‘hypothetical contract’ which showed that the wage earner was a ‘disguised employee’. The fee paid to the worker’s company would then be taxed as a salary.
In the intervening years, IR35 has been the source of many difficulties, as well as ingenious systems designed to circumvent it. At the heart of the problem is the rather fluid borderline between employment and self-employment, and the underlying case law. HMRC have tried to simplify this with their online questionnaire, which emphasises the fact that it is the service provider’s responsibility to assess whether or not he or she is a disguised employee and, therefore, should apply IR35.
The costs of the application of IR35 can be considerable for the supplier who becomes liable to Income Tax and to both employee’s and employer’s NI. Furthermore, he or she is entitled only to a deduction of 5% for general expenses (and restricted allowances for travel and subsistence).
A complete restructuring of IR35 has long been expected. There is to be consultation on the detail of the rules to apply from 2017, but the recipient of the services where they are a public body such as the NHS, state schools or local authorities will be tasked with determining whether IR35 applies to the contract and if it does they will have to deduct the appropriate tax and NI and pay over employers NI.
Usually these bodies will lean towards the safe side and automatically apply IR35. As this will incur additional costs, they can be expected to pass these onto the supplier by reducing the price for the services.
This only applies to services, not goods. Typically it will affect very small or ‘one-man’ companies or sole traders providing consultancy services to government bodies. If this applies to you, ensure that you take it into account when tendering for contracts that may extend beyond 5 April 2017.