What is IR35?

IR35 legislation was implemented in April 2000. These changes were introduced by the Inland Revenue to counter tax avoidance (not evasion) in the area of service provision (i.e. Private Limited Companies). The contractor community in general (and IT contractors in particular) were identified as “tax avoiders”, resulting from the tax saving benefits they enjoy when working through a Private Limited Company, while performing roles similar in nature to those of permanent employees.

The Inland Revenue initially stated that the legislation targets were ‘Friday to Monday’ workers (permanent employees who return the next Monday morning as contractors). It has since become clear that IR35 has been implemented and targeted at contractors but not just those in the IT sector. The Revenue argued that if the agency and or the service company were removed, a large number of contractors would really be “disguised employees” who should be included on the client payroll and have tax and NIC deducted each month. It’s scope has increased beyond this sector and careful consideration needs to be made as to whether your contract is “caught” in IR35 or not? Again help is at hand from Legal Practioners, PAYE Payroll Service or Umbrella companies, some accountants and of course the Inland Revenue, if you are not sure seek advice. The Government announced the “rule changes” which would take effect from 6 April 2000. The first reporting and payments would be due from 19 April 2001.

IR35 has resulted in increased National Insurance liabilities, administration and significant reduction in recoverable expenses for those contractors using a Private Limited Company and in some cases has removed the option of trading as a Private Limited Company altogether(see below). In short, for the majority of contractors this is no longer a financially attractive option. However, its demise has increased the popularity of Payroll Companies (Umbrella) as the preferred payment vehicle and increasing numbers of experienced contractors are also migrating to this trading style.

Does IR35 apply to you?

IR35 applies to all contractors who do not meet the Inland Revenue definition of “self employment”. As a rule of thumb, if you only have one current contract, you travel to the same workplace each day, you are paid by hour or day rate, you work under the jurisdiction of the client and you have no right of substitution (i.e. if you cannot go into work that day, you cannot send a replacement in your place) then you will probably fail the Inland Revenue’s self employment definition and it is likely you will be trapped by IR35 legislation.

IR 35 & Case Law:

Contractor employment status under IR35 legislation depends on the interpretation of both employment and IR35 case law. It’s an important issue, because contractors judged to be inside IR35 can face significant bills from HMRC for additional taxes, interest and penalties.

Case Law Defined:

The definition of case law from the online legal resource Duhaime (www.duhaime.org). is as follows: “If a rule of law cannot be found in written laws, lawyers will often say that it is a rule to be found in ‘case law’. In other words, the rule is not in the statute books but can be found as a principle of law established by a judge in some recorded case. “A basic principle of the law applies whereby, once a decision (a precedent) on a certain set of facts has been made, the courts will apply that decision in cases which subsequently come before it embodying the same set of facts. A precedent is binding and must be followed.” This means that if one contractor with a particular set of circumstances is found by a tax tribunal or court to be inside IR35, another contractor with very similar circumstances will almost certainly be found inside IR35, as the lessons from the first contractor’s case will be applied to the second contractor’s.

Case Law and HMRC

When investigating a contractor, HMRC relies heavily on existing case law, and might even choose to investigate and push certain cases to tribunals and the courts so that new case law can be tested. In its leaflet ES/FS1(formerly IR56), which is designed to help employees and the self-employed determine employment status, HMRC states that it considers case law to be the principles guiding employment status. ES/FS1 says: “The law for tax, NICs [National Insurance Contributions] and VAT doesn’t define employment or self-employment. Generally, when we look at employment status, we apply the principles established by the courts. These principles are generally referred to as case law.” HMRC’s regularly updated Employment Status Manual includes a comprehensive list of relevant cases and case law. The organisation’s Litigation and Settlement Strategy clearly states that HMRC will pursue some cases, regardless of the tax yield, where an important point of tax law is at test. Case law evolves – generally not to contractors’ advantage!

Clearly, therefore, contractors who wish to remain outside IR35 need to keep on top of changing IR35 case law.

Case law is not static and changes over time as different interpretations of laws are made. Since the introduction in 2000 of IR35, many cases have been heard in tax tribunals and the courts, generally resulting in rulings that have gradually refined the case law. When investigating a contractor, HMRC relies heavily on existing case law, and might even choose to investigate and push certain cases to tribunals and the courts so that new case law can be tested. HMRC naturally interprets existing case law in favour of finding contractors to be disguised employees who are therefore inside IR35. Often tribunals and courts have been sympathetic to this view, which means that the general evolution of IR35 case law has been against contractors’ interests. This is because where there were previously grey areas, commissioners and judges have ruled one way or the other to settle any ambiguity, thereby creating more case law.