IR35, which was first mooted in March 1999, was then the latest attempt by the UK Government to address the problem of “status” for tax purposes: is an individual an employee or self-employed for tax purposes? However IR35 (which came into effect via FA2000) took the issue beyond a simple question of status as it was specifically aimed at countering the growing use of “intermediaries” (generally, but not always, limited companies) being used to disguise what HMRC believed were actually employments. Those using intermediaries believed that placing the intermediary between the “employer” and the individual put the individual at one step removed and thus it was more difficult to sustain that the individual was employed by the person to whom he/she was providing services. The fact that payments would not be made directly to the individual was also a factor.

Established employment law had almost invariably held that the interposition of a company prevented the individual being employed by the main contractor. Thus where the contractor contracted with a service company and that company provided the services of the worker to the contractor then, pre IR35, the individual would not be considered to be an employee of the contractor. There was a variation to this general principle in Cable & Wireless v Muscat [2005] where it was found, as a fact, that in spite of Mr Muscat having a service company he was an employee of Cable and Wireless.

It is generally a question of fact as to whether an individual is self-employed or an employee. Neither employment nor self-employment is defined in statute. The guiding factors in determining status have been built up over the years mainly via Employment Tribunals. It’s unusual for any one factor to be decisive one way or the other.

If an individual is working via an intermediary (usually a company), the IR35 legislation requires that company to consider whether the relationship between the individual and the client would have been one of employment, had the company not existed. IR35 is conceptually simple. It asks ‘would the worker have been employed by his client if there was no intermediary?’ If the answer is yes, the engagement falls within IR35 and the worker’s company has either to pay the earnings as salary, or account for National Insurance contributions and PAYE on deemed salary.

A key feature of IR35 was that the PAYE burden would fall on the intermediary and not the principal contractor. In effect the risk (which would lie with the contractor if there were no intermediary) was transferred to the intermediary. This was an incentive for contractors to insist that those providing services do so via an intermediary. It is probable that many of those providing services did not appreciate this and also did not appreciate that they may have lost potential entitlement to employment rights.

To understand fully the reasons why “status” and IR35 are perceived as being so important to the various parties (HMRC, main contractors and sub-contractors) one needs to consider the outcomes for these parties if the individual falls on one side or other of the dividing line:

• The statutory rules determining whether an expense is deductible for tax purposes, if incurred by an employee, are a somewhat higher hurdle than those which pertain to deductions for the self-employed or for companies.
• The contractor does not have to operate PAYE in respect of payments to an individual who is self-employed or in respect of payments to an intermediary who employs that individual (assuming IR35 does not apply). There is both an administrative advantage to the contractor and a timing of receipt of tax disadvantage to HMRC.
• Employer’s NIC at 13.8% provides a powerful incentive for the contractor not to treat the individual as an employee.
• Incorporation, as many practitioners will know, is fiscally attractive in its own right. The abolition of advance corporation tax in 1999 would have also been a factor.
• A contract for employment confers certain rights on the employee. E.g. entitlement to sick pay or maternity leave, entitlement to notice or redundancy pay and a right to claim for unfair dismissal. Equally these rights of the employee are responsibilities of the employer.

This latter point has been a historically important factor in “status” cases. As noted above the guiding factors in determining “status” have been built up over the years mainly via Employment Tribunals.

An individual is taken on temporarily to provide services. Five years later they are still in place providing services and being paid without deduction of tax. The contractor decides that they are no longer required and terminates the arrangement. At this point the individual realises that their rights and entitlements would have been considerably better were they treated as an employee. The matter proceeds to the Tribunal for a determination as to whether or not he or she was in fact an employee. Each case is a question of fact determined on its particular fact pattern. Over the years the Tribunals devised a set of rules to help them in their determinations.

For those with intermediaries the introduction of IR35 did not address the loss of employment rights. If IR35 was effective in a particular case in effect PAYE had to be operated but this did not confer employment rights on the individual.

The following are a list of factors developed over the years which indicate employment status (these are not exhaustive):

• Mutual Obligations – where the payer is under an obligation to provide the worker with regular work and the worker is under an obligation to make himself available.
• Contract of service – where the worker is bound by the terms of his contract to be available to perform general services (usually for an indefinite period) rather than a specific task.
• Remuneration package – an employed person is likely to be paid a fixed wage or salary on a regular payment date. He will also normally participate in the company pay, benefits and pension schemes on the same terms as other employees, and be entitled to paid holiday, sick leave and notice of termination.
• Performance bonuses – bonuses are traditionally considered by HMRC to suggest employed status.
• Exclusivity – an employed person will not normally be free to work for other employers whilst under contract, without the express permission of his employer.
• Facilities – an employer will normally provide an employed person with the facilities and equipment required for him to do his job.
• Integration – an employed person will normally be recognisable as part of the organisation e.g. his name may appear on the internal telephone directory and email address list.
• Benefits in kind – the provision of benefits such as company cars normally suggests a longer-term employment relationship.
• Expenses – an employed person will normally reclaim from his employer all personal expenses he incurs in the performance of his duties.

The following are a list of factors which would indicate self-employment status (again these are not exhaustive):

• Substitution – a self-employed person may have his own partners and employees who he can send in his place to undertake the work in his absence. The power to appoint a substitute has been the subject of recent case law and has been viewed as a crucial test. A blanket licence to supply services through a substitute is considered as inconsistent with an employment.
• Financial risk – a self-employed person will normally risk his own capital in his business and will be personally responsible for any losses arising.
• Commission-only work – a person who receives no flat fee and whose earnings are based on commissions (e.g. commission-only salesmen) is more likely to be classified as self-employed.
• Equipment – a self-employed person will normally provide his own tools and equipment.
• Existing status – a self-employed person may have already established the taxation status of his business.
• Choice – a self-employed person will normally be free to provide his services to whichever customers he chooses without operating exclusively for one company.
• Control and supervision – a self-employed person will normally use his professional expertise to determine how, where and when he conducts his work, without being under the direct supervision of the payer.
• Contract for Services – a self-employed person will normally have a contract stipulating a specific service to be delivered within a set time frame.
• Remedial work – a self-employed person will normally be required to correct unsatisfactory work in his own time and at his own expense. He will not normally be paid overtime.
• Basis of pay – a self-employed person will normally be paid by reference to the volume of work produced.
• Hours of work – a self-employed person will normally be free to decide the time when he will do the work and the place where he will do it.

Establishing the answer to the question raised by IR35 can be very difficult. There are no definitions of employment and self-employment and instead the tests, which derive from numerous cases, need to be applied. These are subject to adjustment as new decisions emerge. The complexity creates a huge grey area. In practice those potentially affected by IR35 adjust the contracts under which they work, so that they contain terms indicating that they are outside IR35. For example, their written contracts give them rights of substitution (see recent Deliveroo case), require them to provide their own equipment, and state that they are not subject to the control of the engager.

IR35 has been far from a resounding success for HMRC. It was originally estimated that it would raise £900m per annum. However it has been reported that it actually raised £2m per annum in the years up to 2009. In recent years HMRC has seen massive reductions in headcount and probably do not have the resources required to properly enforce the regulations. Allied to this is that the subject is complex, so that IR35 enquiries have proved to be very time consuming, with a less than 10% success rate for HMRC in those cases which have been enquired into.

In practice the majority of those potentially affected, rather than comply, have sought to escape IR35 by restructuring their working arrangements. The legislation may have had some deterrent impact in its earlier years but the lack of enforcement and the apparent lack of success in HMRC’s efforts mean that any current deterrent impact is likely to be minimal.

An alternative to IR35 might be to reduce the differences between the taxation of employments and the self-employed. A major difference at the moment is in the NIC rates applied. Currently NIC raises £130bn per annum and no government will wish to reduce that by any meaningful amount. Recent events show how politically difficult it is to raise NIC rates on the self-employed. Even were Income Tax & NIC, imposed on the self-employed and employees, aligned there would still be the alternative to incorporate where an owner manager can arrange matters so that he/she suffers no NIC on what is their reward from the company.

In any event HMRC has decided to persist with IR35.

From April 2017 the responsibility for deciding if IR35 should be applied shifted from the worker’s intermediary to the Public Authority the worker is supplying their services to. This only applies to Public Sector “employers”. What was expected to happen in actuality was that many “employers” in the Public Sector would adopt a cautious approach i.e. subject sub-contractors to PAYE regardless. HMRC provided guidance and an online tool which should be treated with caution. Thus far the placing of the burden onto Public Sector Contractors is reported to be a success and there is a belief that the Treasury will be tempted to introduce it into the Private Sector in 2018. The Chancellor did not directly announce anything in the November Budget statement but a consultation on introducing the new measures into the Private Sector has been announced.

In the Public Sector the administrators so far have been inclined to adopt a defensive, risk averse position i.e. they will treat their contractors as employed. Whether this will continue is another matter. As they meet resistance from their sub-contractors (and find it harder to engage them), become more familiar with the actual technical issues and come to realise that HMRC is not on the door step the Public Sector administrators may over time evolve their approach.

The Private Sector’s inclination (if the PAYE burden is shifted) will be less defensive and unless HMRC is prepared to police it there may not be the hoped for rise in tax revenues. There are probably very few intermediaries currently contracting to Private Sector contractors who are voluntarily operating PAYE. Transferring the PAYE burden to the principal Contractor may not make much difference but doing so may create an enormous political hue and cry.

The Future

It is unlikely that the Treasury and HMRC will do a U turn and there is a strong possibility that the 2017 changes will be applied to the Private Sector. In the author’s view those upon whom the potential burden will fall, i.e. the principal contractors, will demand that an intermediary is in place and will seek to ensure that there is a contract for services which ensures that the engagement falls out with IR35. Public Sector employers may follow suit.

Many smaller workers and contractors may simply continue to ignore the provisions.

Pat Donnelly is a Senior Manager with PKF-FPM.

Email: www.p.donnelly@pkffpm.com