The act, the myths and the future of IR35
In the 1999 budget, the then Chancellor Gordon Brown announced measures to counter large scale tax avoidance through the use of Personal Service Companies (PSC).
A PSC is not strictly defined in law but the government definition is “someone who works through their own limited company” as opposed to someone who’s self-employed and pays Class 2 and 4 NICs.
The Intermediaries Legislation, as IR35 is properly known, was announced on the same day as the budget statement in an innocuously sounding pre-budget press release called Inland Revenue (now HMRC) no.35 “Countering Avoidance in the Provision of Personal Services”.
So the IR in IR35 stands for Inland Revenue and 35 is the press release number. Still with us? Good.
It came into force in the UK in April 2000 and was backdated to begin its commencement from the start of the financial year which was 6 April 2000, which amongst other things makes it an Aries.
It’s since been consolidated into various other acts of Parliament including the Income Tax (Earnings and Pensions) Act 2003; The Statutory Instrument Social Security Contributions (Intermediaries) Regulations 2000, SI 2000/727 and The Finance Act 2017.
The latter act implemented changes in the process that determined the amount of Income Tax and National Insurance Contributions to be deducted from a worker.
Why where they set up?
What began as a fairly niche financial activity finally got the government’s attention in the 90s as more and more companies and contractors started using the PSC loophole.
The main purpose of IR35 was to stop workers from setting up limited companies that they could be paid through, saving on income tax by being paid as an independent contractor while effectively being an employee.
They could do this through taking all of their yearly wages in a single month so they only had to pay one set of NICs rather than paying a regular contribution monthly like most employees.
It was widely known as the “Friday to Monday” scenario.
A worker could technically leave their job on Friday as an employee and return the following Monday doing exactly the same work for the same company but they’re now an independent contractor paid via their personal service company and receiving a dividend as opposed to regular wages.
This lead to an increase of directors paying themselves dividend payments instead of wages, so enjoying a tax rate lower than income tax.
The IR35 press release cited that this arrangement was an anomaly that would be corrected in the budget.
It also announced that HMRC would begin to investigate the contractual arrangements between a worker’s PSC and their client company in order to determine if the worker was actually a “disguised employee” – the term they use to identify PSCs that are actually vehicles for disguised remuneration.
If they positively established that this relationship was disguised then any fee paid to the PSC would be eligible to be taxed as a salary and at a higher rate.
A lot of single-employee limited companies or PSCs operate through specialist external recruitment/supply agencies. These agencies have contractual agreements with client organisations to supply individuals to work on various projects. The agency then finds an appropriate PSC or single employee company to supply their services.
The responsibility for determining whether or not a contract is “within IR35” and therefore eligible for income tax and NICs and deducting the appropriate rates depends on whether the hiring client is in the public or private sector.
If they’re in the public sector then the responsibility lies with the client or agency who pays the PSC. If they’re deemed to be inside IR35 then they will also have to pay any and all dues to HMRC.
At the moment the private sector has a different approach, at least until April 2020 when the law changes to make it more coherent with the public sector.
Until then it’s the responsibility of the PSC contracted to do the work to determine whether their contract is inside IR35. If this is the case, they’ll have to pay all eligible income tax and NICs to HMRC.
In the next article we’ll look at the actual advantages and disadvantages of IR35 and what criteria HMRC look for when they try to establish the status of a contractor.