We have been dealing with IR35 and in that time nothing has really changed. Uncertainty and confusion still rules the day. The truth of the matter is the HMRC have only carried out 542 IR35 investigations in the last 5 years to April 2014 with an average yield of £5.7K per enquiry (HMRC minutes, Feb 2015).
The low number of investigations hardly encourages those contractors who work on the fringes of needing to comply with IR35 to change their minds over whether they need to revise their approach to IR35. They know they face a very low risk of ever having to justify their position on their tax employment status.
There is no doubt that the change to the way dividends received will be taxed on the individual, not to mention losing the right to claim travel and over-night expenses from 6th April 2016 for “Personal Service Companies” will significantly reduce the tax advantages for operating through a company. It seems likely to us that there will be far less reason for the HMRC to investigate IR35 cases in the future as the net yield from such activities will be substantially less too.
HMRC guidance on IR35.
From April 2017, anyone working through a company or partnership in the public sector will no longer decide whether or not they are within IR35. This responsibility will instead fall on the public-sector employer, agency or third party. As the public-sector employer, agency or third party will have to pay the tax if they get it wrong it is anticipated that most will apply IR35.
The HMRC Guidance Brief on IR35 published in June 2014 continues to remain in force. If you have not already done so, you should read the guidance brief as it gives a very good idea of how the HMRC will be approaching an IR35 enquiry. Remember the rules they are trying to establish, are the ones they would like you to play by. They are not set in stone – at least not yet. I mention this because I have trouble seeing the commercial reality of some of the guidelines. For example, suggesting a 10% bad debt annual figure is an indicator of self-employment is ridiculous. I have never met a business that could sustain a 10% bad debt attrition rate without going out of business, especially in these harsh economic times.
The Employment Status Indicator (ESI).
This is another step in the right direction taken by the HMRC to help tax payers. According to the HMRC web site, completing the ESI tool will provide an indication of your employment status. Click here to try out the ESI tool.
The answer can be relied upon as evidence to support your position, provided your answers to the ESI questions accurately reflect the terms and conditions (not just the written contract) under which you provide your service and the ESI has been completed by your engager. If you just complete the ESI tool the result is only indicative.
The Contract Employment Status Tool (CEST).
HMRC have now produced a “Contract employment status tool” which gives their view on whether an engagement falls within IR35.
What is the Answer to IR35?
When asked by my clients why there isn’t a simple answer to IR35, I often point out there is! The safest and most obvious option is to put your case directly to the HMRC’s Specialist IR35 Review Service while you are still in contract. You will then obtain a definitive and reliable answer from the HMRC as to if IR35 applies to that contract. For some reason, few contractors want to take up this safe option. I wonder why?
One of the problems with IR35, is that despite the handful of highly publicised cases that have been tested in the High Court, only 542 IR35 enquiries have been undertaken in the 5 years to April 2014. HMRC continue to beat their drums over enforcing compliance but in reality, fail to deliver the number of investigations that would force the massive pool of directors of personal service companies to stop chancing their luck. The lack of visible enforcement by the HMRC has led many people into a false sense of security. It is one thing to decide that IR35 does not apply to you and collect written evidence to support your employment status decision on the off-chance you may have to justify it to the HMRC one day in the future. It is a whole different ball game if you only rely upon the odds of never being chosen by HMRC for an IR35 review.
Do you have cause to be concerned?
Being completely objective, it is hard to understand why the HMRC has not launched a major tax recovery campaign on Personal Service Companies. There is every indication they will collect in an average of £5.7K per enquiry in extra tax revenue. One can only presume the HMRC are suffering a shortage of trained staff to carry out the reviews and/or the return on investment in opening enquiries is not high enough to justify expanding the operation.
The fact that you will be paying more tax on the dividends you take from the 6th April 2016 will only serve to lower the yield of an adverse IR35 review in future years anyway.
What you should be doing now.
We can debate IR35 until the cows come home, but the latest HMRC guidance confirms what I have been recommending for years. As a contractor, your priority will always be to make sure each job you undertake is for a defined and distinct ‘project’ preferably of less than six months. During the execution of that project you collect and collate every shred of evidence that supports your view that IR35 does not apply.
You should record the results of applying the HMRC’s Business Entity and ESI tests to each contract. If the results point to self-employment, you can take comfort that the HMRC will probably view the contract as outside the scope of IR35 as well. If the factors are evenly balanced, then you must accept there is a higher risk the HMRC may disagree with your tax treatment. In this case the quality and quantity of evidence you have collected in to support your tax treatment of a contract will be crucial to you successfully defending your position if the HMRC do take an interest in your affairs. If the results point to employment, then you would be well advised to seek professional advice about complying with IR35. To not do so may result in you suffering significant penalties if the HMRC later investigate you.
What follows is the information the HMRC specify they will require to be able to make a decision as to whether IR35 applies or not. You can safely assume the same level of detailed documentation will be required by you to defend an aggressive IR35 enquiry review: HMRC need your full co-operation to establish the facts relating to the engagement and will need to see copies of any contracts involved in the relationship. You should send copies of these contracts to the IR35 Customer Service Unit together with any other relevant information, such as:
- any other documentation relating to the working terms and conditions;
- written statements from the worker and the client about their views of the working terms and conditions with emphasis on what happens in practice;
- details of how the engagement was obtained and the recruitment procedure together with a copy of any adverts for the work in question;
- a description of the nature of the services to be performed together with any job or work specifications for the contract;
- copies of any tenders made by the intermediary;
- details of any additional contractual terms not included within the written contracts, whether oral, written or implied;
- details of how and who allocates the work and the role the worker plays in the client’s organisation i.e. does he or she work alone or as part of a team;
- other relevant information from the worker or intermediary – for example this might include:
– the number of engagements held during the year;
– the number of different engagers; and
– expenditure on equipment necessary for the performance of the contract.
If your contracts fall into the grey danger zone of IR35 compliance and you do not retain the written evidence above to support your decision not to comply with the IR35 rules, then I think you will not be able to successfully defend an IR35 enquiry should you be unlucky enough to suffer one. We cannot stress enough the need for contractors to collect in every shred of evidence that supports their decision not to apply IR35 while they are still in contract at the time. Trying to do it after the event will prove difficult, if not impossible.
Avoid wasting your time looking for answers that don’t exist.
Expanding any further on the content of the previous paragraphs is a fruitless exercise. It is easy to be misled into making the wrong decision over IR35 if you start reading all the material available on the Internet. Just because a thousand people say the Earth is flat, does not make it so. Unfortunately, the same level of credibility applies to much of what is published about IR35 on the Internet. Most of it is either wishful fantasy or just plain wrong.
It is worth remembering that the only opinion that matters at the end of the day, is that of the HMRC and that of course assumes they have taken the step of opening an enquiry into your contract history. Until then it is all just conjecture and one can spend hours going round in circles debating what is the right course of action to take.
Please – Do.
The IR35 decision is always going to be a subjective one. So, if you decide you are going to treat a border-line contract as outside the scope of IR35, all you must do is make certain you collect in every piece of written evidence that supports your view of your self-employments status. Keep it all on file and just hope you will never have to rely upon it should you be unlucky enough to be selected for an HMRC IR35 review in the next six years. You might also consider it prudent to keep back a modest contingency fund in border line contracts just in case the HMRC pick up on it and decide against you in the future.
Please – Don’t.
The one thing you definitely should not do, is work your way through the next six years of contracts with no written evidence on file to support your case that they all remain outside the scope of IR35 except accept retaining one half of an unsigned, so-called IR35-friendly contract. If you are unlucky enough to suffer an IR35 enquiry in those circumstances … well to put it politely … you are hopelessly up a creek without a paddle. I rather suspect that far too many people are in this position now. All I can suggest is that making a start to correct matters is the best piece of advice you will ever receive on IR35.
Tax Data Ltd can help you.
If you feel like talking about your specific circumstances call me, Mike Devine, on 01737 551904.You should also visit the HMRC IR35 Forum website. It is the best place to keep a check on what the HMRC is really doing with IR35.
Published 13 September 2017.
Updated December 2017.