IR35 is considered to be one of the main pieces of legislation affecting contractors and freelancers as its implications affect the way in which they are paid and their tax liabilities.
An employee would leave his employment on a Friday afternoon and return to work the following Monday to do the same job but not as an employee of the original employer. Instead he would be employed by an intermediary (a personal service company of which he would be a controlling shareholder/director) through which his services would be supplied to the original employer. The intermediary would invoice the original employer for these services and would receive a gross payment.
Through coming to the above arrangement the original employer would avoid paying Class 1 NIC at 13.8% and the (former) employee could arrange his payments between salary and dividends in order to minimise his tax and NI liabilities. The government therefore introduced anti-avoidance legislation known as IR35 in April 2000 with the purpose of countering this problem.
The IR35 legislation applies to individuals who provide their services through an intermediary (usually a personal service company) where the income received for performing the services would have been treated as employment income had the individual contracted directly with the customer (without the intermediary). The tests used in deciding if somebody is employed or self employed can therefore be used in deciding whether an engagement is caught or exempt from the IR35 legislation.
There is no single straightforward test to determine the status of an engagement as there is no specific rules in statute - however the generally adopted approach is to look at all of the relevant factors of the engagement including the contract under which their services are performed and the actual working practices of the contractor. The main areas looked at include, but are not limited to:
- Right of Substitution
- Mutuality of Obligation
- Right to Control
- Provision of Equipment
- Financial Risk
- Basis of Payment
- Client Integration
The above contractual indicators would not be examined in isolation and so the existence of a single indicator would not be conclusive. In addition to this, the actual working practices would be examined along with the contract under with the person is engaged - it is therefore important that the actual working practices of the contractor are reflected in the contract. More and more are we seeing the contract being overlooked by Inspectors and reliance being placed on the working practices themselves to determine the IR35 status.
The above are areas that would generally be examined by somebody with specific legal expertise in this area and as such the determination IR35 status falls outside of the scope of the work undertaken by Nixon Williams - we recommend having your contract examined and then reporting back to us whether you are caught or exempt.
If an engagement falls within the scope of IR35 (if the client states that their contract is caught by the legislation following professional review of the above tests), they are required to pay the majority of their income (less a few qualifying deductions) as salary - this is referred to as their IR35 'deemed salary'.