Few pieces of tax legislation have been as controversial, as much derided and as unsuccessful as IR35. Famous for causing HMRC to change the way they numbered their press releases, IR35 seeks to create a legal fiction for tax purposes, by lifting the corporate veil (as my company law lecturer used to say, investing it in my view with quite unwarranted sexual connotations, possibly inspired by the story of Herod, Salome and the head of John the Baptist) and seeking to tax an underlying employment relationship despite the presence of a corporate (or partnership) intermediary.
Despite its chequered past, HMRC is still determined to make IR35 or some variant thereof, work, as two recent developments have demonstrated. I will deal with the first today, and the next later in the week.
For a long time HMRC has offered on its website an Employment Indicator Tool, devoted to the highly dubious concept that it is possible to determine someone’s employed or self-employed status by answering a few questions on a computer. The have now adapted this idea with an update to their IR35 guidelines, introducing a points system to identify the risk of a commercial arrangement falling within IR35. Now this is irresistible for a statistics addict like me (I told you in a previous post you would never guess what I was addicted to) so I had to look more closely.
The idea is that the guide poses a series of questions, to which yes answers generate points (in one case negative points). And what do points make, as Bruce Forsyth used to ask on Play Your Cards Right? No, not prizes in this case, but a low risk of IR35 applying to your contract.
I can tell you are dying to know, so here are the questions and the point allocations. Less than 10 puts you at high risk of IR35 applying.10 to 20 is medium risk (incidentally what does that mean? You are either within IR35 or not) and more than 20 is low risk.
- Does your business own or rent separate business premises that are separate from your home and client’s premises? (10)
- Do you need professional indemnity insurance? (2)
- Has your business had the opportunity in the last 24 months to increase your business income by working more efficiently e.g. by finishing the work/project earlier than projected but still receiving the full agreed payment? (10)
- Does your business engage one or more workers who generate at least 25% of your business turnover annually? (35)
- Have you been engaged on PAYE employment terms by your current client / end user within the last financial year with no significant changes to your working arrangements? (-15)
- Has your business invested over £1,200 on advertising, excluding entertainment in the last 12 months (2)
- Does your business have a business plan with cash flow forecast, that is regularly updated, and a business bank account that is separate from your personal account and identified as a business bank account by the bank? (1)
- Would your business have to bear the cost of having to rectify any mistakes? (4)
- Has your business been unable to recover payment for work done during the last 24 months in excess of 10% of annual turnover? (10)
- Do you invoice for work carried out prior to being paid and negotiate payment terms? (2)
- Does your business have the right to send a substitute? (2)
- Has your business hired anyone in the last 24 months to do the contracted work you have taken on? This could be demonstrated by sending a substitute in your place or by sub-contracting, but in both cases your business remains responsible for the work and for paying the substitute or sub-contractor. You can still pass this test if you had to notify the end user of the name of the individual you sent as a substitute. (20)
This is clearly intended only as a guide, and neither HMRC nor taxpayer is going to be bound by the results. But there are some bizarre inclusions and exclusions here, which make me wonder how much practical use this will prove to be:
1 – this would be completely unnecessary in a number of businesses, which can quite happily and efficiently be conducted from an office or workshop at home.
2 – this is also completely unnecessary in many businesses.
5 – this begs the question what is a significant change? I used to be guaranteed work now I am not – is that a significant change? (see below).
6 – this assumes that advertising works, which is a big assumption in my experience.
7 – an awful lot of business don’t have a business plan and cash flow forecasts.
9 – that’s an awfully big bad debt, which would be sufficient to cripple many small businesses.
11/12 – #11is only worth 2? A requirement for personal service is a prerequisite for an employment to exist, or for IR35 to apply. My first, and often only, question to an engager wishing to treat someone as self-employed is “do you require them to do the work themselves?” If the answer is yes, I tell them that the person in question is an employee. If the answer is no, I tell them to put a substitution clause in the contract, along the lines outlined in #12. There is an implication in the point allocation for this question that the terms of a commercial contract are effectively meaningless, which is absolute rubbish. A substitution clause gives the right to supply a substitute, and that is that.
A sensible engager will insist upon the substitute being appropriately qualified, experienced, knowledgeable etc, but that is just commercial common sense. And of course they will want to know who is coming to their premises; I haven’t been let into any HMRC offices lately without identifying myself and normally passing through a scanner, and I assume they don’t expect businesses to be less careful about access to their premises?
Giving 20 for #12 just emphasises the inadequacy of the point allocation for #11. It is sheer chance whether it is necessary for a contractor to send a substitute at any point in the contractual relationship, or whether the parties can work around holidays, illness etc without that being required. And should the application of IR35 be established by sheer chance? I think not.
Should I be advising clients to make sure they send a substitute at least once at the start of a working relationship to clear them for IR35 purposes, and if so does that not encourage a degree of cynicism in applying the guidelines? What if the contractor is anxious not to send a substitute in case the client prefers the substitute? Is that a legitimate reason to apply IR35 to the contractor? Again I think not – it has to be the legal right of substitution that matters, not whether it happens to have occurred in practice.
And what about the number of customers a contractor has? Does having multiple customers rather than 1 not give a greater indication of true self-employed status? And what about mutual obligations, which employment tribunals have found to be a critical factor time and again in determining employment status? Does it not matter if the engager is required to provide work, or the contractor to accept it? Of course it does, very much.
The addition to the guidelines is a good idea, but the checklist is incomplete, in places irrelevant and the point allocations are ill thought-out. The idea that one could establish one’s status under IR35 by applying this checklist is frankly laughable, and it is dangerously misleading for HMRC to give taxpayers the impression that they can.
Lemexie commented on this post:
“Your recent excellent analysis on IR35 and Tax Avoidance could maybe be combined when considering the case of a Ltd Company providing an interim FD to a failing NHS Trust (in the press yesterday) at £3,000 per day. Questions arising might be (a) ethics of the day rate fee from NHS funds (especially give the announcement in effect said the organisation was insolvent) and (b) whether being an interim FD meets the new HMRC tests of IR35.”
I suspect Lemexie of being clairvoyant, as he was anticipating my post yesterday about the consultation document on controlling persons, which I suspect is intended to cover precisely the type of situation he illustrates. From this I think we might deduce that the government is concerned that IR35 might indeed not cover the FD in question. I am right with him on the ethical issue too.