IR35 - the taxation of personal services
The IR35 legislation, due to come into force on 6 April, is sending shock waves through the construction industry. In the first of two articles, Kevin Miller, a chartered accountant and a director of the 6,000 strong Professional Contractors Group, answers some important questions on the proposals and their impact.
What is the issue?
The Government's concern is that any individual working through their own intermediary company can choose to treat the company's income as profit out of which they can take dividends - on which no National Insurance (NI) is paid - rather than as salary subject to NI. Those who work in a partnership benefit from lower rates of National Insurance contribution applicable to the self employed.
Who are the rules aimed at?
They may affect any workers who provide services to businesses - but not to private individuals - via another business (known as an intermediary), in circumstances where had the worker supplied the service direct to the client they would be judged to be an employee of that client rather than self employed.
Many individuals working in the construction industry might be caught but the rules apply equally to IT consultants, interim managers and any other professional who tends to work mainly for one client at a time.
The 'intermediary' is typically a service company in which the worker must either have a shareholding of at least five per cent, or receive payments or benefits which are not subject to tax under schedule E but can reasonably be taken to represent remuneration. It can also be a partnership in which the worker is a partner or, exceptionally, a self employed individual who employs another self-employed worker.
The situation is complicated by the fact that connected persons of the worker (typically lineal ancestors or descendants and siblings), are treated as if they are the worker. Therefore a worker employed by a company owned by their spouse could also be caught. These rules apply whether the work is obtained via an agency or by contracting direct with the client.
How can I prove that I really am self employed?
This is judged by the employment (schedule E) and self- employment (schedule D) tests. These tests are not set out in any statutes but are based on judgements in tax law cases. There are a dozen or more well established criteria that have been used by the courts to define self employment status, but some of the most critical include: having the right to get a substitute or helper to do the job; not being subject to the client's control over what, when, where and how the work is done; having to provide your own equipment; taking financial risk and having the opportunity to profit from sound management; being able to work for more than one client at a time; not being part and parcel of the organisation; and not having any expectation of being offered or accepting further work.
If the relationship with the client fails tests like these, it will be regarded as 'disguised employment' by the Revenue. Under IR 35 income from disguised employment will be treated as if it came from employment. That is, the intermediary must treat the gross income as if it were a 'deemed payment' to the worker made up of salary subject to PAYE and the related employer's NI. This deemed payment is subject only to deductions for a general expense allowance of five per cent of the disguised employment turnover, deductions for expenses which any employee can claim, such as travel, company contributions to the worker's pension scheme and professional indemnity premiums.
For someone working through their own company and currently taking most of their income as dividends out of profit rather than as salary this could mean a drop in post tax income of up to 25 per cent. For those who work as partners or as a sole trader this could mean most of their income being liable to employer's NI at 12.2 per cent.
Kevin Miller's second article on IR35 will appear on 20 April.