The ‘IR35’ rules are intended to prevent the avoidance of tax and National Insurance Contributions (NICs) using personal service companies (PSC) and partnerships.
The rules only affect you if you:
Thus this could affect you if you provide your services through a company and have one or two customers for whom you effectively work full-time. On the other hand, if you provide your services to many customers you are far less likely to be affected.
The rules do not stop you supplying your services through your own company or a partnership. However, they do seek to remove any possible tax advantages from doing so.
The IR35 shorthand reference to these rules dates back to when they were first introduced by the 35th IR press release of the Chancellor’s Budget in 2000.
Removal of tax advantages
The tax advantages mainly arise by extracting the net taxable profits of the company by way of dividend. This avoids any NICs which would generally have been due if that profit had been extracted by way of remuneration or bonus. The new dividend tax structure which came into effect from 6 April 2016 will also impact on the benefits of operating via a limited company.
The intention of the rules is to tax most of the income of the company as if it were salary of the person doing the work.
If you are within the rules
The main points to consider if you are within the IR35 rules are:
Providing services to the public sector
Effective from April 2017, the rules for individuals providing services to the public sector via an intermediary such as a PSC has changed. The new rules shift the responsibility for deciding whether the IR35 legislation applies from the intermediary itself to the public sector receiving the service.
HMRC’s guidance will help public authorities, employment agencies, and other third parties who supply labour to identify if the contracts they have are within the scope of the changes. The new provisions apply where a worker personally performs services or is under an obligation to personally perform services for a public sector client.
In addition, the worker must be providing the services via an intermediary (usually a PSC) and the services must be such that if the contract had been directly with the client, the worker would be regarded for Income Tax purposes as an employee of the client.
The new rules also bring managed service company’s (MSC) within the scope of the new rules if all the conditions outlined above apply. The 5% flat rate allowance that currently applies to PSCs will also be removed when working with the public sector.
There are a number of scenarios that fall outside the scope of the reforms. For example, there is separate guidance where an agency directly employs a worker supplied to the public sector and PAYE and NIC is deducted. The rules will also not apply where a public authority has fully contracted out services to a service provider and the workers do not personally provide their services to the client.
Whilst the IR35 rules have not changed it is likely that the public sector receiving the services will take a more stringent approach to applying the rules. There are concerns that many agency staff will move away from supplying services to the public sector and instead work in the private sector where the changes do not currently apply.
Employment v self-employment
The question as to whether you would be an employee or not (but for the use of your company) is fundamental to the IR35 rules. The taxman will want to know how the relationship operates between you and your client regardless of the terms of any agreements or contracts. These will also be important but they cannot change the facts. This is because the dividing line between employment and self-employment has always been a fine one. All relevant factors will be considered, but overall it is the intention and reality of the relationship that matters.
The table below sets out the factors which are relevant to the decision.
HMRC have published guidance designed to help contractors self-assess their possible liability to the IR35 rules.
The Business Entity Tests (BETs) that businesses could take to self-assess their risk of IR35 were withdrawn with effect from 6 April 2015. HMRC will not re-visit a closed enquiry based on a result of the BETs within the 3 year period previously notified to the business.
Exceptions to the rules
If your company has employees who own 5% or less of the shares, the rules will not be applied to the income that those employees generate for the company.
Note however that in establishing whether the 5% test is met, any shares held by ‘associates’ must be included.
How the rules operate
The company operates PAYE & NICs on actual payments of salary to the individual during the year in the normal way.
If, at the end of the tax year - ie 5 April, the individual’s salary from the company, including benefits in kind, amounts to less than the company’s income from all of the contracts to which the rules apply, then the difference (net of allowable expenses) is deemed to have been paid to the individual as salary on 5 April and PAYE/NICs are due.
Where salary is deemed to be paid
Income and expenses
The income included in the computation of the deemed payment on 5 April includes the actual receipts for the tax year.
The expenses are those incurred by the company between these two dates.
Those working through a PSC can no longer claim travel and subsistence costs as expenses and incur tax relief on these costs.
Timing of Corporation Tax deduction for deemed payment
A deduction is given for the deemed payment against profits chargeable to Corporation Tax as if an expense was incurred on 5 April. This means that relief is given sooner where the accounting date is 5 April.
Will the company make a taxable loss because of the legislation?
If a company’s expenses are high the company may make a taxable loss. This can only be relieved by carry forward against future trading profits.
One reason why the projected expenses will create a loss would be where the company pays a spouse a salary. The amount of the salary may need reviewing if the IR35 rules start to apply.
Payments made by your company into a personal pension plan will reduce the deemed payment. This can be attractive as the employer’s NICs will be saved in addition to PAYE and perhaps employee’s NICs.
Extracting funds from the company
For income earned from contracts which are likely to be caught by the rules, the choices available to extract funds for living expenses include:
The advantage of paying a salary is that the tax payments are spread throughout the year and not left as a large lump sum to pay on 19 April. The disadvantage is fairly obvious!
Borrowing from the company on a temporary basis may mean that no tax is paid when the loan is taken out, but it will result in tax and NICs on the notional interest on the loan. There may also be a need to make a payment to HMRC equal to 25% of the loan under the ‘loans to participators’ rules.
The payment of dividends may be the most attractive route. If a deemed payment is treated as made in a tax year, but the company has already paid the same amount to you or another shareholder during the year as a dividend, you will be allowed to make a claim for the tax on the dividend to be relieved to avoid double taxation.
The company must submit a claim identifying the dividends which are to be relieved.
There is a tight deadline for the calculation of the deemed payment and paying HMRC. The key dates are:
Interest on overdue tax is chargeable from 19 April if tax and NICs are underpaid on the basis of provisional figures.
It is therefore in your interests to have accurate information on the company’s income and expenses on a tax year basis and, in particular, separate records of the amount of the company expenses which will qualify as ‘employee expenses’.
Where individuals supply their services through a partnership, the rules are applied to any income arising which would have been taxed as employment income if the partnership had not existed. In other words, where a partnership receives payment under an ‘employment contract’:
Partnerships excluded from the rules
Many partnerships are not caught by the rules even if one or more of the partners performs work for a client, which may have the qualities of an employment contract.
The rules only apply to partnerships where:
Where a company or partnership fails to deduct and account for PAYE/NICs due under the rules, the normal penalty provisions apply.
If the company or partnership fails to pay, it will be possible for the tax and NICs due to be collected from the individual as happens in certain circumstances under existing PAYE and NIC legislation.
Managed Service Companies (MSCs)
MSCs were a widespread attempt to avoid the IR35 rules. Some were known as ‘composite companies’ or ‘managed PSCs’.
In 2007 the government introduced legislation which applies to MSCs. The rules:
MSCs are required to account for PAYE on all payments received by individuals.
This form of 'composite' company is unaffected by the MSC legislation. Umbrella companies also enable contractors to operate as though they have a PSC without them having to set it up and run it themselves. The big difference though between MSCs and Umbrella companies is that the latter make all payments to the contractor through the PAYE system. There is no facility to secure tax savings through the payment of dividends.
We can advise as to the best course of action in your own particular circumstances. We can also assist you with: