By ACCA’s Budget team
What is it?
Intermediaries legislation designed to prevent individuals using company law (i.e. setting themselves up as one-wo/man companies) to avoid tax and National Insurance. It’s named after the press release where it first appeared (the 35th press release from the-then Inland Revenue about the 1999 Budget) and has been in place since 6 April 2000.
IR35 seeks to prevent contractors avoiding tax and National Insurance by treating them as employees for tax purposes.
When IR35 applies, the intermediary (not the customer) is deemed to be the employer and the worker is treated as the employee of the intermediary. The income under the contract is subject to PAYE and National Insurance and the intermediary must account to HMRC for the deductions.
IR35 has no effect on employment law, so the deemed employee acquires no employment rights.
Where does it come from?
A leather merchant named Mr Salomon. Well, IR35 wasn’t actually his idea, but the legal recognition of the fact that a corporate personality is a separate legal person to its members, dates back to the Salomon v Salomon & Co court case from 1897. One-man companies have been with us since then.
The Finance Act in 1972 triggered an explosion in demand for such companies. Suspecting widespread tax evasion in the construction industry, the Treasury produced legislation requiring building contractors to deduct tax before paying sub-contractors unless they were dealing with a company, in which case the company could be paid gross.
Why does being a one-man company help?
The main advantages of trading through a limited company are that:
- A contractor can draw a minimum salary and pay the minimum tax and National Insurance, drawing profits as dividend out of post-tax profits of the company; there is no further tax on the distribution, except where the contractor has a liability to higher rate tax.
- This gives rise to a National Insurance saving (no NI on dividends) and a cash flow advantage, since dividends do not attract PAYE.
- The rate of corporation tax is substantially lower than the total of income tax and National Insurance.
- For contractors such as IT and other professionals, there is the opportunity to work from home. This can give rise to substantial cost savings (see below).
- Agencies engaging contractors are saved the cost of employer’s National Insurance.
Why am I reading about IR35?
Because it’s riddled with problems and the Chancellor might make some changes to it on Wednesday.
To begin with, IR35 tests for employment are different for income tax and National Insurance and can throw up different results for the same purpose.
Then there’s the fact that there’s no definition of ‘self-employment’ in statute and so there’s a lot of complicated case law to go through for guidance as to self-employment/employment (including: Lime-IT v Justin 2002; Synaptek v Young 2003; Tilbury Consulting Ltd v Gittins (No2) 2003; and Novasoft Ltd v HMRC 2010 – if you want more detail on these cases, get in touch on Twitter with @ACCANews).
Those looking to take advantage of IR35 have to wade through all this and then decide if they are within the boundaries of IR35, which can be very difficult to work out. They also have to work out exactly what tax and National Insurance they’re supposed to be paying with a risk of penalties if they get it wrong.
It is no exaggeration to say that IR35 is not at all popular with contractors. It is equally true that it is disliked by their advisors, principally because of the uncertainty as to whether their clients are caught or not. Given the strict penalty regime for getting things wrong, it is understandable that it makes a lot of people very nervous.
When IR35 was introduced, the Government estimated that it would generate £900m per annum in additional tax revenues. However, IR35 has actually only raised less than £2m a year in tax revenues. This is dwarfed by the cost of setting up and administering the scheme and, consequently, has actually cost the taxpaying public heavily, as well as the heartache caused for contractors and their advisors.
A survey of the Professional Contractors’ Group established that of the 1,500 of their members investigated by HMRC, only 7% were found to be within IR35.