Dealing with HMRC

Can IR35 clearance be given by HMRC?

HMRC expects workers, intermediaries and clients potentially affected by IR35 to use its online “check employment status for tax” (CEST) tool to determine if a contract is caught or not. While this tool has been significantly improved there might be occasions when individuals need to consult HMRC more directly.

It has a specialist unit dealing with IR35 enquiries. The staff there are professional and helpful.

They can be contacted in writing, by phone or e-mail:

 

HM Revenue and Customs

IR35 Customer Service Unit,

S0733,

Newcastle Upon Tyne,

NE98 1ZZ

United Kingdom

0300 123 2326

email: ir35@hmrc.gov.uk

Where HMRC is reluctant to express an opinion regarding IR35 status, the issue can be forced by asking it to make a formal decision under the Social Security Contributions (Transfer of Functions, Etc.) Act 1999.

What’s HMRC approach to IR35?

IR35 is a big issue for HMRC, in fact it devotes an entire manual to the question of employment status. It can be helpful and is a great deal more coherent than it might at first sight appear, and so if an engagement is faced with a challenge from HMRC it’s worth looking at this in some detail (see here).

However, ultimately there is no substitute for reading the judgments made by the various courts. It is these and the legislation and not HMRC’s views that determine employment status and IR35 matters. Court judgments can be complex, but they can be persuasive in a dispute of status with HMRC. Quoting the appropriate case and the judge’s comments can stop a wayward tax inspector in their tracks.

How likely is an IR35 investigation?

HMRC’s attempts to enforce IR35 since its introduction have not been very successful. Despite having specialist units, HMRC is trying to police a large number of personal service companies and investigating them is very time consuming.

There are two further problems that stack the odds against HMRC:

• It will often find both the worker and the client ganging up on it to agree that IR35 does not apply, or the client simply does not want to get involved.
• There is frequently no money left in the company anyway, so even if HMRC wins a case it will fail to collect much if anything in tax and NI.

In essence, HMRC chooses its IR35 battles carefully and is only likely to take on a case where the circumstances suggest a win. Therefore, the more careful the individual is about the way they provide services so as not to flag them as a potential employee, e.g. working set days and hours and generally avoiding being integrated into a client’s organisation, the better.

Do the off-payroll rules affect the likelihood of an enquiry?

HMRC has said that it won’t use the new rules to open IR35 enquiries into earlier years. In a statement about IR35 and off-payroll working at the end of October 2019 HMRC set out its stall regarding managing and enforcing the rules after April 2021. While there’s no change to the principles which determine if IR35 applies, HMRC says it has “...taken the decision that it will only use information resulting from these changes to open a new enquiry into earlier years if there is reason to suspect fraud or criminal behaviour”.

In practice this means the amnesty only applies if the information which could lead HMRC to start an enquiry into earlier years comes out of “...information resulting from these changes...”. For example, if an individual is working under a contract for which they’ve decided IR35 doesn’t apply, but from April 2021 the business they were working for decided it does, HMRC will not investigate the decision unless it has evidence that the individual deliberately acted contrary to the law, e.g. they falsified documents or facts to support the view that IR35 didn’t apply.

Where IR35 could apply to work, that is, an individual personally provides services to a client but invoice them through an intermediary (company, partnership, agency or another person), they should keep a record of how they arrived at the view that it didn’t apply. This can include results produced by HMRC’s Check Employment Status for Tax (CEST) tool.

What sort of evidence is important in an IR35 enquiry?

It goes without saying that HMRC will look at the contract, but it will also ask questions not just of the individuals, but other parties that might be involved.

An interesting article was published in February 2008 by a former HMRC inspector who had been involved in some IR35 cases that had gone to tribunal. He analysed four - two won and two lost by HMRC - and concluded that a great deal revolved around the credibility of the witnesses. In particular, in the two cases that HMRC won the judges had been impressed by the testimony of the end client, whereas in the two that HMRC had lost, they had not.

Individuals should Counteract this by contacting their client, preferably before HMRC can get to them, speaking to the people who actually know how the contract functions. In the two cases that HMRC lost their witnesses were simply too far from the action. A tribunal is more likely to pay attention to a line manager than an HR person.

If control is a point of issue in an HMRC IR35 enquiry, it is worth comparing and highlighting differences between the worker and normal employees of the client.

How should an HMRC compliance check be handled?

In many ways an IR35 compliance check is like any other tax compliance check. However, like all status enquiries it is advisable to avoid meeting HMRC as there are a great many pitfalls. Bear in mind that tax inspectors can, and very likely will, make arrangements to see one or more clients and may not tell the business that it is doing so. In other words, no special approach from is needed and anyone under enquiry should stick to the facts when communicating with HMRC.

Are there special reporting rules to identify payments potentially caught by IR35?

Since 2016 agencies, e.g. those who find work for IT contractors, have been required to report payments they have made to intermediaries, e.g. personal service companies, to HMRC. It has resources to investigate all the people working through a given agency.

Where a salary is paid out of income that is subject to IR35, the usual routine and time limits apply. That is it must be reported using payroll software and PAYE real time information (RTI) on or before the date it is paid.

However, where IR35 deemed pay applies for a year, tax plus employers’ and employees’ NI must be paid to HMRC no later than 19 April following the 5 April on which the deemed payment was calculated. Where the cannot calculate can’t be worked out before then, it should be reported using the RTI earlier year update procedure no later than the 31 January following the end of the tax year.

What if there is more than one business activity?

A business might consist of more than one activity. HMRC makes the point that, for example, an accountant might spend most of their time in conventional accountancy work, but also do some lecturing.

HMRC will accept that the lecturing forms part of the accountancy business, provided that it is relatively small compared with the whole business and closely related to it (for example, the lecturing must be in accountancy and not some unrelated topic). Therefore, unless there is a contract of employment for the subsidiary work, HMRC is happy to wrap it up with the main work without much consideration as to its status.

IR35 tax and NI regulation

So far we’ve looked at the importance of contracts on employment status and the approach taken by the courts and HMRC in respect of employment status. We now need to look at how tax and NI law fits in.

The relevant legislation is in ss.48 to 61 Income Tax (Earnings and Pensions) Act 2003 (ITEPA), and its NI equivalent in s.4A Social Security (Contributions and Benefits) Act 1992 (SSCB) and Social Security Contributions (Intermediaries) Regulations (SI 2000/727).

We are assuming that there is no direct relationship of employment, and that the agency (ITEPA ss.44-47) and managed service company (ss.61A to 61J) rules do not apply as these would take precedence over IR35 rules if they do.

What is an intermediary?

IR35 applies where there is an intermediary. That is where the individual and their end client don’t have a direct contract because there is an intermediary in the chain, e.g. a company, partnership or an individual. The legislation is aimed principally at personal service companies, that is, companies set up to provide the services of an individual.

For s.49. ITEPA to apply, meaning IR35 is applicable, three tests must be passed, essentially these reflect what we have already said, but for the record are:

1. The individual must personally perform, or be obliged to personally perform, services for the client. The service must be provided by them personally or a substitute where the client places restrictions on them.

2. The services are provided not under a contract directly between the individual and the client, but under arrangements involving a third party, typically, but not necessarily, a company.

Note. This will catch pretty much any intermediary case. Notice the use of the word “arrangements” - the legal precedents suggest that this can mean almost anything, and is certainly not confined to a written contract.

3. The circumstances are such that:

• if the services were provided directly under a contract between the individual and the client, then the individual would be regarded for income tax purposes as an employee of the client or the holder of an office under the client; or
• the individual is an office holder (essentially a director or company secretary) who hold that office under the client and the services relate to the office.

Note. The position of company officers, directors and company secretaries, under IR35 is not specifically covered here, firstly because they are a rarity; secondly, because PAYE and NI are charged on officers as they are for employees, and the IR35 laws will equally apply.

The effect of the legislation is that it’s necessary to look at the contract and arrangement the company (or other intermediary) has with the client, and its contract and arrangement it has with the worker, as if they were a single arrangement. In other words, merge the terms of contracts and and arrangements decide if the three tests are passed thus making IR35 applicable.

There are some further conditions concerning the nature of the intermediary in s.51 to s.53, but these are not considered here as they are not likely to be of much use in getting out of IR35 rules.

How do the rules for contracts fit with those for IR35?

The starting point for IR35 cases is the assumption that the written contract doesn’t give rise to an employed relationship - obviously, if it did, PAYE would be payable by virtue of that and not of any IR35 legislation.

We therefore start from the “arrangements” and the “circumstances” - in other words, from the facts on the ground. The written contracts are evidence of these, but should bear no more weight than anything else.

HMRC might wave away terms of a contract (that doesn’t help its viewpoint) as not being relevant. However, the contracts with clients and those of the company or other intermediary, e.g. a work agency, form part of the “arrangements” and IR35 legislation requires that they be taken into account. HMRC cannot just ignore them.

What’s the position where work is provided through an agency?

Often, especially in the IT sector, a company contracts with an agency, which contracts with the client to provide the services. The contract between the agency and the client is very likely a bulk contract dealing with a large number of people. In that situation the individual is unlikely to get to see it. This can make it very difficult to establish whether IR35 applies or not. Remember, IR35 legislation requires that all contracts should be considered together.

It is at least worth the individual asking for sight of the agency’s contract with the client so that they can view any potentially troublesome clauses in the event of an HMRC enquiry.

The contract between the agency and the company will almost certainly include a right of substitution, which is a key factor in employment status. But is this replicated in the contract between the agency and the client? If not this can be a real problem, which can be enough to sink any defence against IR35. Of course, what the individual doesn’t know they can’t offer or comment on if HMRC asks a question. It will have to dig out this information itself, which on anecdotal evidence alone suggests it is often not able to do.

What is the tax position of work done outside the UK?

IR35 does not apply in circumstances where there would be no ordinary liability to PAYE, such as where the individual is non-resident and the work is performed outside the United Kingdom.

Where they are resident, but not domiciled in the UK, and the work is done outside the UK, technically speaking the IR35 position depends on whether the individual uses the remittance basis, i.e. opt to pay UK tax on unremitted overseas income, or not.

Because the option to use the remittance basis or not might be uncertain at the time of payment, under a contract potentially subject to IR35 it is better not to use a UK-based company in such circumstances.

Where individuals are resident in the UK and the services are provided in the UK, the intermediary is treated as having a place of business in the UK whether or not it has one, so IR35 will apply as if it did.

What is the NI position of work done outside the UK?

There is provision similar to that for income tax for overseas intermediaries to be liable. However, where the client is overseas and the work is done overseas the NI position may be different. Cross-border NI is one of the most complicated areas in the British tax system. If it might come into play individuals are advised to contact an NI tax specialist.

Does operating through a company make a difference?

Some of the conditions have more relevance to IR35 situations than others. For example, it would be unusual for a contract with an intermediary company to provide for any benefits to be granted as a form of remuneration, or a right not to be unfairly dismissed. A company contract can therefore be said to start with an in-built pointer towards self-employment. It is, all things considered, probably not a very strong one, though.

IR35 calculations

The IR35 rules apply slightly differently depending on whether the individual, their client, or an agency, are responsible for putting them into practice. The following explanation sets out the steps required where the individual is making the calculations of IR35 tax and NI.

Where the IR35 rules apply they deem that a payment of salary has been made to the worker. The amount of the deemed payment is equal to the income subject to IR35 after deducting actual salary paid and certain actual and notional expenses (see Case study 3).

The calculation is made as if the payment were made on the last day of the tax year (5 April), unless the company or other intermediary ceases trading, in which case it is made on the last day of trading.

If the individual ceases to be a shareholder, director or employee of the company etc. the deemed payment is made on the date of that event.

The deemed payment is deductible for corporation tax purposes in the intermediary’s financial year in which the corresponding 5 April falls.

How is the deemed payment worked out?

Unless there are special reasons, e.g. the requirement for limited liability, for using a personal service company where it is thought IR35 will apply (unless the amount of income it applies to is small in comparison to the overall income of the business), it is best not to do so. The cost in terms of tax, NI and administration is quite high, plus the work involved requires time that could be better spent elsewhere, given that there is no real tax and NI advantage to be had.

The IR35 calculation is made in steps:

• add up all the company’s IR35 receipts, and taxable benefits if there are any
• deduct 5%
• add the value of anything else received
• deduct expenses that would be exempt if the individual were employed by the client
• deduct any capital allowances the individual would be entitled to if they were an employee of the client
• deduct any contributions to registered pension schemes made by thecompany on the individual's behalf
• deduct any employers’ NI paid during the year
• deduct any employment income actually paid by the company to the individual as salary and benefits.

The result is the amount of IR35 deemed payment.

Where IR35 applies, rather than get involved in the deemed payment calculation it will be simpler for the individual to pay them self an amount which, together with employers’ NI, comes to 95% of the amount in question, as actual salary.

What are the special rules for travel expenses?

Certain deductions for work expenses can be made before applying the IR35 calculation. However, the Finance Act 2016 changed the rules, excluding the deduction of home-to-work travel expenses in certain circumstances. These took effect for travel expenses incurred on or after 6 April 2016.

Where IR35 applies, the new rules also apply. If the relationship would count as an employment if the PSC was taken out of the equation, meaning IR35 would almost certainly apply, a block on deductions for home-to work-travel costs applies.

Are there exceptions to the rules?

Tax deductions for home-to-work travel (the home to the client’s premises) are still allowable where a genuine temporary workplace in involved. For example, if the individual is usually based at a client’s Manchester office, but have to travel to their Rochdale premises for a few days and this wasn’t part of the working arrangement, the cost of travel to and from home is tax deductible.

A temporary workplace is one which an individual doesn’t attend, or expect to attend for a continuous period of more than 24 months, or for most of the engagement.

Where a tax deduction for the cost of travel can’t be claimed, the individual is also not allowed to claim a deduction for related subsistence costs.

What’s the effect of deemed payments on other taxes?

One important thing is that the tax and NI cost of HMRC determinations (rulings) that IR35 applies can generally be reduced by two different types of claim. It is important to make these claims on time.

1. The first claim concerns the deemed payment of salary, which is eligible for deduction against the company’s etc. taxable profits. There can be difficulty in that the individual will only claim a corporation tax deduction for a deemed payment once they know that they have lost the IR35 case.

This can only be done between two and four years after the end of the accounting period in which the income subject to IR35 arose (see Appendix C). The trouble is HMRC can look back six years; also, IR35 investigations can take a very long time to complete. It is important therefore to put in a claim for the earliest years as soon as possible to avoid losing out on tax relief for the deemed payment.

Unless a claim is made within the self-assessment amendment window (usually twelve months from the end of the financial period in question), the claim will be under the overpayment relief rules and will be provisional until the IR35 position is agreed. If the investigation is not complete, put in a provisional claim.

As a deemed payment is not an actual expense for the company, legislation invents one for corporation tax purposes. This can be found in s.139 of the Corporation Tax Act 2009. If the time limit is missed a special relief will need to be applied for, which is in effect given at HMRC’s discretion and so should be seen as a last resort.

2. Bear in mind that the PAYE part of an IR35 claim may include higher rate and additional rate income tax, which may well already have been paid by the company shareholder on the same income, but as dividends. If so, relief under s.58 ITEPA can be claimed which has the effect of reducing the dividend and so giving relief.

A provisional claim for relief needs to be made within five years from the 31 January following the date of the deemed payment, e.g. if a deemed payment applied on 5 April 2020, a claim must be made by 31 January 2026. However, if not done in time, special relief is the only solution and it is far harder to make a successful claim for this.