Thursday, May 20, 2010
IR35 was brought in to prevent the payment of less tax and national insurance by using a personal service company or partnership to provide services through rather than being a direct employee.
For example, by using a personal service company it has been possible to extract income from the company in the form of dividends rather than salary so saving substantial amounts of national insurance. In addition, shares of the company may be split with the spouse of the worker to help avoid higher rate tax and there is far more that can deducted in the way of tax deductible expenses by operating through a company rather than as an employee.
The regulations are applied where a worker supplies services through a relevant intermediary (which can be a company, partnership or individual), to a client and had the worker contracted directly with the client, the income would have been treated as employment income for tax purposes. The status tests outlined below are used to help determine whether the worker would have been treated as an employee or self-employed if they had contracted directly.
Large amounts of tax and NIC are at stake. Every case needs to be judged on its merits and several factors need to be considered in coming to a conclusion on whether a contract is caught or not.
HMRC can provide an opinion on whether the contract is caught by IR35 or not, but do not provide opinions on draft contracts. Unsurprisingly perhaps, the view of HMRC often tends to come down on the side that the contract is caught by IR35 but very often their view has been shown to be wrong and should not be accepted without further investigation. Whether HMRC should also be asked for their opinion also needs consideration.
A company is a relevant intermediary for the IR35 rules if...
■the worker (together with his close family and business partners) controls more than 5% of the company; OR
■the worker receives payments or benefits which are not salary but which could reasonably be taken to be payment for services provided to the client
For partnerships the IR35 rules are only applied when any of the following apply...
■a partner (together with his close family) has more than 60% of the profits;
■most of the partnership profits come from the work of a single client;
■where a partners share of the profits is based on their income from the relevant contracts.
The Calculation
Any salary paid during the year has PAYE operated on it in the normal way during the year.
However, where there is income that is caught by IR35, then to the extent that it exceeds any salary to which PAYE is already applied plus taxable benefits, the excess will be treated as a deemed salary and is treated as pay on 5th April, and is liable to PAYE and Class1 NIC's accordingly. This makes the extra tax and NIC payable on 19th April following the tax year concerned, which is a very short timescale so contractors need to be organised. Interest runs on underpayments from this date.
In arriving at the excess salary, certain expenses can be deducted from the income derived from IR35 contracts as follows...
■a flat rate allowance of 5% of the net of VAT income;
■expenses that would have been allowable as an employee - this includes travel from home to the client's premises as long as the job is expected to and does not last more than 24 months;
■employer pension contributions;
■employer national insurance contributions;
■some capital allowances.
The excess amount is treated as being inclusive of employer's Class 1 NIC, so these are deducted to arrive at the deemed salary on which tax and NIC is calculated.
The deemed payment and employers NIC payment thereon are then deductible expenses for the intermediary company, treated as if paid on 5th April.
If actual salaries are paid later of amounts that were included in the deemed salary calculation, they cannot be paid free of tax and NI as they only reduce the salary payment of the actual year in which they are paid. To avoid potential double taxation it is better to use dividends.
If caught by IR35, the method of extracting funds from the company once the deemed payment calculation has been applied needs to be considered. For example...
■A salary could be paid during the year to avoid a large tax and NIC payment on 19th April but it does mean you pay the tax earlier.
■It is possible to borrow from the company and then repay the borrowing out of a salary nearer the 5th April. There can be tax and NIC on the notional interest on the loan and it is possible a payment to HMRC of 25% of the loan will be required if the loan is not repaid in full within nine month of the company's year end.
■Paying interim dividends in the tax year following the deemed payment and then claiming for the dividend not to be treated as a dividend for tax purposes relieved to avoid any double taxation - this is often the best way forward.
Status Tests
In determining whether the contract is caught by IR35 it is necessary to consider the existing tests developed over the years to determine whether an individual is employed or self-employed. These tests can be summarised in one question: Is the individual in business on his own account when offering services to the client? If the answer is not a definite 'yes' the following factors need to be considered...
Requirement to provide a personal service
■Must you complete the work personally?
■Can you send substitute to do the work?
Control and supervision of the worker by the client
■Can you work at times to suit you?
■Does the client control how you do the work?
Mutuality of obligation between the parties for the duration of the contract
■Do you have the option to turn down work offered and does the client have the option not to offer work?
■Is each side obliged to other work and accept work?
Financial risk of the worker■Do you correct defective work in your own time, at your own cost?
■Are invoices raised by reference to the job rather than hours worked?
■Is public liability insurance in place?
■Is work carried out for more than just one or a very small number of clients?
Provision of equipment and materials by the worker
■Do you use your own equipment?
■Are materials supplied by you?
■Do you work from your own premises?
■Does your company have its own business stationery?
Trappings of employment
■Is holiday and sick pay paid to you by the client?
■Are any employment type benefits provided to you by the client?
■How long have you been working for the client?
■Is there a notice period to end the arrangement?
Intention of the parties
■What was the intention of the parties in forming the contract?
The first three factors are the most important. If one of these does not exist the contract does not have the attributes of an employment contract so must be another type of contract, such as a self-employment relationship. However to determine whether the worker is self-employed the other factors also need to be considered. If you would like to discuss the above, then email me neil.harries@harrieswatkins.com
Image: FreeDigitalPhotos.net
For example, by using a personal service company it has been possible to extract income from the company in the form of dividends rather than salary so saving substantial amounts of national insurance. In addition, shares of the company may be split with the spouse of the worker to help avoid higher rate tax and there is far more that can deducted in the way of tax deductible expenses by operating through a company rather than as an employee.
The regulations are applied where a worker supplies services through a relevant intermediary (which can be a company, partnership or individual), to a client and had the worker contracted directly with the client, the income would have been treated as employment income for tax purposes. The status tests outlined below are used to help determine whether the worker would have been treated as an employee or self-employed if they had contracted directly.
Large amounts of tax and NIC are at stake. Every case needs to be judged on its merits and several factors need to be considered in coming to a conclusion on whether a contract is caught or not.
HMRC can provide an opinion on whether the contract is caught by IR35 or not, but do not provide opinions on draft contracts. Unsurprisingly perhaps, the view of HMRC often tends to come down on the side that the contract is caught by IR35 but very often their view has been shown to be wrong and should not be accepted without further investigation. Whether HMRC should also be asked for their opinion also needs consideration.
A company is a relevant intermediary for the IR35 rules if...
■the worker (together with his close family and business partners) controls more than 5% of the company; OR
■the worker receives payments or benefits which are not salary but which could reasonably be taken to be payment for services provided to the client
For partnerships the IR35 rules are only applied when any of the following apply...
■a partner (together with his close family) has more than 60% of the profits;
■most of the partnership profits come from the work of a single client;
■where a partners share of the profits is based on their income from the relevant contracts.
The Calculation
Any salary paid during the year has PAYE operated on it in the normal way during the year.
However, where there is income that is caught by IR35, then to the extent that it exceeds any salary to which PAYE is already applied plus taxable benefits, the excess will be treated as a deemed salary and is treated as pay on 5th April, and is liable to PAYE and Class1 NIC's accordingly. This makes the extra tax and NIC payable on 19th April following the tax year concerned, which is a very short timescale so contractors need to be organised. Interest runs on underpayments from this date.
In arriving at the excess salary, certain expenses can be deducted from the income derived from IR35 contracts as follows...
■a flat rate allowance of 5% of the net of VAT income;
■expenses that would have been allowable as an employee - this includes travel from home to the client's premises as long as the job is expected to and does not last more than 24 months;
■employer pension contributions;
■employer national insurance contributions;
■some capital allowances.
The excess amount is treated as being inclusive of employer's Class 1 NIC, so these are deducted to arrive at the deemed salary on which tax and NIC is calculated.
The deemed payment and employers NIC payment thereon are then deductible expenses for the intermediary company, treated as if paid on 5th April.
If actual salaries are paid later of amounts that were included in the deemed salary calculation, they cannot be paid free of tax and NI as they only reduce the salary payment of the actual year in which they are paid. To avoid potential double taxation it is better to use dividends.
If caught by IR35, the method of extracting funds from the company once the deemed payment calculation has been applied needs to be considered. For example...
■A salary could be paid during the year to avoid a large tax and NIC payment on 19th April but it does mean you pay the tax earlier.
■It is possible to borrow from the company and then repay the borrowing out of a salary nearer the 5th April. There can be tax and NIC on the notional interest on the loan and it is possible a payment to HMRC of 25% of the loan will be required if the loan is not repaid in full within nine month of the company's year end.
■Paying interim dividends in the tax year following the deemed payment and then claiming for the dividend not to be treated as a dividend for tax purposes relieved to avoid any double taxation - this is often the best way forward.
Status Tests
In determining whether the contract is caught by IR35 it is necessary to consider the existing tests developed over the years to determine whether an individual is employed or self-employed. These tests can be summarised in one question: Is the individual in business on his own account when offering services to the client? If the answer is not a definite 'yes' the following factors need to be considered...
Requirement to provide a personal service
■Must you complete the work personally?
■Can you send substitute to do the work?
Control and supervision of the worker by the client
■Can you work at times to suit you?
■Does the client control how you do the work?
Mutuality of obligation between the parties for the duration of the contract
■Do you have the option to turn down work offered and does the client have the option not to offer work?
■Is each side obliged to other work and accept work?
Financial risk of the worker■Do you correct defective work in your own time, at your own cost?
■Are invoices raised by reference to the job rather than hours worked?
■Is public liability insurance in place?
■Is work carried out for more than just one or a very small number of clients?
Provision of equipment and materials by the worker
■Do you use your own equipment?
■Are materials supplied by you?
■Do you work from your own premises?
■Does your company have its own business stationery?
Trappings of employment
■Is holiday and sick pay paid to you by the client?
■Are any employment type benefits provided to you by the client?
■How long have you been working for the client?
■Is there a notice period to end the arrangement?
Intention of the parties
■What was the intention of the parties in forming the contract?
The first three factors are the most important. If one of these does not exist the contract does not have the attributes of an employment contract so must be another type of contract, such as a self-employment relationship. However to determine whether the worker is self-employed the other factors also need to be considered. If you would like to discuss the above, then email me neil.harries@harrieswatkins.com
Image: FreeDigitalPhotos.net
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