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A press release numbered IR35 announced the
Chancellor's intention to tackle the avoidance of tax and
national insurance contributions (NICs) through the use of
intermediaries such as service companies or partnerships.
The proposals and subsequent rules have since become
commonly referred to as IR35.
The proposals targeted circumstances where a worker
would be treated as an employee of the client, if it were not for the
existence of the intermediary. Where this was a limited company, the
worker was able to take money out in the form of dividends instead of
salary.
Dividends are not liable to NICs so the worker would
pay less in NICs than either a conventional employee or a self-employed
person.
The IR35 test
A worker will be caught be the rules if he/she fails
the 'IR35 test'. This test determines whether the worker would be an
employee of the client if the intermediary (e.g. the limited company)
did not exist.
The test aims to 'look through' the circumstances
surrounding the work carried out and determine whether
the worker is really a 'disguised employee' (IR35 applies) or is in fact
independently contracting with the client through a company (IR35 does
not apply).
Scope of the rules
The IR35 rules apply to income earned in respect of
work done under contracts which would have been contracts of employment
if the worker had been working direct for the client ('relevant
engagements').
They do not introduce any statutory definition of
employment or self-employment, so the existing case law still applies to
decide employment status.
Workers with up to 5% share in the intermediary (taking
into account the holdings of family and domestic partners) are not
subject to the rules, unless they receive payments or benefits which are
not taxable as employment income.
Calculations
If you are caught by the IR35 rules, you are treated as
receiving a notional salary on the last day of the tax year (5 April)
equal to the company's gross income from relevant engagements less
certain specified deductions.
You will have to pay over PAYE and NICs on this
notional
salary by 19 April and include it on the year end return P35 by 19 May.
It is evident that there is very little time to process
the
calculations, and H M Revenue & Customs will not penalise the use of
provisional payments and calculations in order to meet the deadlines.
The deductions cover expenses that would normally be
available to direct employees, contributions to registered
pension schemes and the actual salary and employer’s NIC plus the
employer's NIC on the deemed salary.
Also allowed is a 5% flat rate deduction to cover the
company's running costs.
Apportionment
Where a company has relevant engagements and other
business which does not fall within the new rules, allowable expenses
will have to be apportioned. Likewise, if a payment for a relevant
engagement covers more than one worker, the payment can be apportioned
between them on a just and reasonable basis.
Other taxes
Corporation Tax is computed in the normal way,
including the deemed salary and associated employers' NIC as allowable
expenses. VAT operates regardless of any IR35 adjustments.
Dividends and other
payments
Nothing in the legislation prevents a service company
from paying money to the worker or others in the form of dividends, or
retaining cash in the company. It will simply mean that an extra payment
of PAYE tax and NICs will be calculated on 5 April. Dividends which are
reclassified as deemed salary are relieved from tax so the PAYE takes
priority, thus preventing double taxation of the payment.
Amending contracts
Workers who think they may be subject to
the new proposals should consider their position carefully, and should
seriously think about renegotiating contracts so that they are no longer
relevant engagements. Particular items to cover are:
-
getting away from payment at hourly
rates and ensuring that the contract is 'project based'
-
ensuring that the client will accept a
capable substitute worker
-
creating freedom in the way the work
is carried out
-
providing major items of equipment
-
ensuring that there is no 'mutuality of obligation' -
i.e. that the client is not obliged to provide work, nor the worker to
carry it out
It is, of course, essential that the
contracts should actually operate within the scope of the written terms.
Managed Service Companies (MSCs)
New legislation introduced by the 2007 Finance Bill
will deem income received by individuals providing their services
through a MSC to be employment income if not
already treated as such. This means that MSCs will be required to
operate PAYE (from 6 April 2007) and Class 1 National Insurance
Contributions (from a date to be
specified after Royal Assent) on all payments received by individuals
for services provided through such companies. If the MSC rules apply the
IR35 rules are disapplied.
Please
note: This guide is intended to provide basic information only.
Where specific advice is required, we recommend that you seek proper
professional help; either from this firm or other suitably qualified
person or practice. |
