All things IR35…

The IR35 legislation has been around since 2000 and the aim is, as set out in R (on the application of Professional Contractors Group) v IRC (2002) to “ensure that individuals who ought to pay tax and NIC as employees cannot, by the assumption of a corporate structure, reduce and defer the liabilities imposed on employees by the United Kingdom’s system of personal taxation…”

The legislation applies if there is a ‘relevant engagement’, that is, where an individual: (i) provides his/her services to a client which is a business; (ii) through an intermediary; and (iii) in circumstances where, if the arrangements had been directly with the client and not the intermediary, the individual would have been treated as an employee of the client for tax purposes. The effect of the legislation is that such an individual will be taxed in the same manner as though they were an employee.

For example, Scott provides website design services to TechStart Ltd as a consultant through his company Scott’s Services Ltd. Scott does not have an employment contract with Scott’s Services and Scott’s Services does not have any other employees. There is a consultancy agreement in place between TechStart and Scott’s Services under which Scott will be working full time and exclusively for TechStart on an ongoing basis designing its website, taking orders directly from the CEO.

In this situation alarm bells should start to ring as it is likely there is a ‘relevant engagement’ which will come within the scope of IR35. If HMRC investigates Scott’s Services it will look at the substance of the relationship and how the contract is carried out in practice, rather than the contractual documentation alone – there is therefore no point having a ‘non IR35’ contract if it doesn’t match the reality.

If HMRC deems there to be an employment relationship within the scope of IR35 Scott’s Services will be required to pay deemed unpaid PAYE and National Insurance as determined by the IR35 legislation as well as interest on unpaid tax and, potentially, penalties.

This can be a complex area and we recommend seeking legal advice to determine whether there is an IR35 issue. However, we have set out below some key factors to help you recognise the scope of IR35:

• Mutuality of Obligation – Within an employment relationship there is an ongoing obligation for the employer to provide work, and the employee to do the work provided. Such an obligation should not be present in a genuine contract for the services of a consultant/contractor.
• Control – An important consideration is how much control is exerted over the consultant/contractor. Employees are typically under the direct supervision and control of their employers, however a consultant/contractor should be able to demonstrate a certain amount of autonomy over the way they undertake their work. Clauses that specify work location and start/end times, or that require the consultant/contractor to be under the direction, supervision and control of the client, point towards an employment relationship.
• Substitution – The right to provide a substitute is a key factor demonstrating that a contract falls outside the scope of IR35 however, and this is an important point, including such a clause will not magically ensure that the intermediary company does not fall within the scope of IR35. Equally, the absence of a right of substitution will not point definitely to a contract of employment.

As set out above, the contractual documentation must reflect the reality of the situation.   Few clients will accept an unfettered right and there is usually a clause allowing the client to veto the substitute. Provided the ability to veto is based on a requirement for the substitute to have the necessary skills, such a veto will not necessarily lead to the clause being ignored by HMRC as being immaterial. However, the right must still be genuine. If, for example, a consultant/contractor has such a specific set of skills, qualifications and experience that it would be very difficult for a suitable substitute to be found there is a material risk that HMRC will disregard the clause.  This scenario went before a Tribunal in 2008 and the Tribunal found in favour of HMRC. Although multiple factors were considered, the absence of a valid substitution right was a material factor in the decision.

• Nature of Work – Unlike in a typical employment contract, work should refer to set projects or have some form of deliverable that is consistent with a discrete piece of work that is not ongoing. It is advisable to link the contract duration to timeframes for completion of the actual services. It is also helpful if the consultant/contractor provides some or all of his/her own equipment and materials.
• Exclusivity – A contract which prevents a consultant/contractor from providing services to other clients points towards an employment relationship.
• Financial Risk – For a relationship to fall outside of the scope of IR35 the intermediary and the consultant/contractor should be able to demonstrate a level of financial risk, for example agreeing to take out and maintain professional indemnity insurance.

Merrill April

Information contained in this post does not constitute legal advice and is provided for informational purposes only. Recipients should not act upon it, but should seek legal advice relevant to their own situation.