Salvador Dali said “What is important is to spread confusion, not eliminate it”. He wouldn’t have known it but the rules governing the nature of self-employment and the feared IR35 system appear to have been designed with this one aim in mind!
As far HM Revenue is concerned people are employed, work for themselves or trade via a limited company: Partnerships fall into the s/employed category for tax purposes [ NOTE: the taxation of Limited Liability Partnerships changes significantly from 6 April].
The taxman likes people to be employed and on PAYE. PAYE provides much less scope to be cute with tax planning, so employees pay more tax and especially more NI contributions [the employer who pays even more!]. Consequently, the authorities are always on the lookout for self-employed individuals who are really nothing of the sort!
Many readers of “the Lounge” may have clients worried about these rules, so I hope this review is helpful. The rules governing employment status have huge scope to confuse as recent Twitter conversations have shown. Successful challenges over status can be very costly. For advisers who get it wrong for clients it can be doubly so.
The Self-Employment Tests
The main weapon in the armoury of HM Revenue and Customs when they review a person’s claim to be self-employed are rules used to determine the nature of their relationship with their clients; [sometimes called Badges of Trade]. Think of these as the taxman’s version of “if it walks like a duck and swims like a duck..” The rules also affect people running their business through companies so it is important to know them.
The main tests are:-
- Exclusivity: E.G., How many clients a self-employed worker has. Working exclusively for one customer is often taken as a disqualification from being classed as self-employed. It isn’t always, if the other “badges” below are met.
- Financial risk: for example if work set out in the contract takes longer than allowed for in the price, does the supplier have to take overruns on the chin? To be truly self-employed they should do. Any question of paid “downtime” rules someone out of being self-employed.
- Control of work: does the contractor work at their client’s premises? Do they use the client’s equipment etc.? Again, working at an employer’s premises isn’t an automatic no-no: for instance the taxman understands that many bookkeepers work for themselves: they also accept that most of their work is on-site. Continuous “9-5” working wouldn’t look good however.
- Profit motive. Are you in business to make money?? This sounds stupid but more than one tax case has been held to test this badge.
A full list is available on the Revenue’s website. Apart from these definitions governing “substance”, there are some other important points to remember.
- Contract. Any contract signed with a client has to be clearly one for the provision of services, not a contract of employment. We have seen examples of clients who follow the rules only to sign a contract that includes holiday pay, set working hours and sick pay! An exclusivity clause in a contract for services isn’t a good idea either although a lot of clients try to include them: these are regarded with suspicion.
- Just as working for one customer only doesn’t automatically exclude you from being self-employed, so working for multiple clients doesn’t automatically make you so either, especially if you don’t follow the above rules. It is perfectly possible to have [say] three different clients and be employed by all of them.
- If the Revenue successfully reclassify someone as employed, any additional liabilities usually fall on the “employing” business and invoices issued to the customer are reclassified as pay “NET of tax and NI contributions! It is academic if the worker has correctly declared their own taxes: additional liabilities fall due on the “employer”.
Using a Limited Company
Since the risk of a successful challenge over someone’s self-employed status usually lies with the employer, many businesses insist that contractors they use provide their services through a company, in effect passing the risk to them.
With a company the contractor becomes an employee even though they own it. Their company is responsible for paying their own PAYE, including any additional amounts demanded after a successful status challenge.
In the 1999 budget Gordon Brown dramatically changed the UK’s corporation tax system. After this date the low-salary/high dividend route became popular with owner-manager companies when people realised they could save substantial amounts of NI contributions using this structure. The authorities soon realised this too!
In these post-financial-crisis times of fiscal probity it is easy to see the Revenue’s point. Back then though there was outrage when they introduced the IR35 regime, designed specifically to combat perceived abuses. Introduced initially to challenge the huge numbers of “consultants” hired to fix the Y2K bug [that never was], they have remained in force since: indeed their use has been widened.
The IR35 rules examine whether services provided by the consultant’s company fall foul of the tests mentioned above. If they do the effect is to require the company to operate PAYE on 95% of the contractors turnover [certain specified expenses can also be deductible in addition to the 5% allowance].
Contractors supplying their company services through an agency are particularly vulnerable to an IR35 attack. Agency contracts can be tightly worded and may create an employee-employer relationship if care isn’t taken.
In the end, as in much of the UK tax regime every case is different and will turn on its own merits and questions of fact. One specific situation to avoid is a contractor working exclusively for a client for one year or more at a time, at least on the same contract.
An “IR35 event” can often be avoided by thorough planning. Advice in this difficult area is essential, preferably before the taxman comes knocking!