Probably no tax legislation has been so written about as the so-called IR35 . This legislation relates to personal service companies (PSC's) and people trying to avoid tax and national insurance contributions (NIC) by sticking a company in between them and their client. As a leading firm of Chartered Accountants providing PSC services to consultants contracting in the Aerospace, Automotive and IT industries, Nyman Linden's views on IR35 are always being sought. Not only have many readers of this newsletter been contacting the firm about this issue, but also one of their clients has just won a long-running battle with the Inland Revenue regarding his status under IR35 . In this issue of in touch, Andrew Plaskow – a Partner of Nyman Linden – gives his explanation of IR35 and comments on his client's recent judgement.

the benefit
By operating through their own PSC, a highly paid individual can save both employer's and employee's NIC if he takes money out by way of dividends (which are not NICable) rather than take it all by way of salary.

the history
For years and years, we all jogged along quite nicely setting up a PSC often when an individual left employment (on paper) on a Friday afternoon and came back as a company contractor on Monday morning. As PAYE simply doesn't apply to companies, the individual had found a way to throw off the straightjacket that PAYE imposes on tax and NIC payers.

Unfortunately, the whole thing became much too popular. When virtually the entire IT and telecom industries were being run through these PSC's, Gordon Brown stamped on it. The Budget Press Release in which the new rules were announced was numbered IR35, hence the name.

the rules
After a bit of tweaking (following protests from the accountancy profession and industry), the final form of the IR35 rules, which have stayed with us essentially since 2000, was as follows.

Where an intermediary (PSC) was placed between a worker and the user of the worker's services (and, but for the existence of that intermediary, the relationship would have been one of employer and employee), tax and NIC are imposed on that intermediary company as if it had paid out all of its income (except for certain modest expense allowances) as salary to the individual concerned.

So, bang went all the opportunities to save NIC.

To read the government announcements at the time, anyone would think this was a nice and simple procedure to follow. They did not seem to realise that the question of whether a person would be employed or self-employed is actually a very difficult one to determine. There is a long list of cases where employment or self-employment status has been disputed and they by no means present a coherent picture.

Although the courts do not seem to have adopted a consistent approach to deciding the question of whether a person is employed or self-employed, the tendency is to look at all the different features of the relationship and see which ones point to an employment relationship and which to a self-employment relationship.

There are a number of myths in this area - for example, the idea you have to work for more than one person to be self-employed, or you must not work for the same person for too long a period. Ultimately, it's the element of control that matters and these are very peripheral indicators.

how to avoid IR35

The first and most obvious way to get out of IR35 is to steer clear of the employment indicators and, instead, try to establish the self-employment ones listed above. The most important way of doing this is to have a written contract that emphasises your freedom from employment-type features.

Of course, it is not just the written contract that is important but also the way the actual assignment works in practice. If your contract says you are as free as a bird but you actually work from 9 to 5 and are ordered around from pillar to post, such day-to-day reality supersedes the written contract.

HM Revenue and Customs (HMRC) Inspectors very often trot out this argument. But they often forget it is necessary for them to have solid evidence that the actual reality is different from the contract. It is by no means unusual for Inspectors to come out with this statement about the contract not being conclusive without providing anything that actually points in a different direction. Such attacks are easy to ward off.

It is very important, though, for this reason that minimal contact is permitted between HMRC Inspectors and individual workers. Not knowing what the real issues are, these can very easily be led by the Inspector, by selective questioning, to say things that support the Inspector's case. The rule should be, if possible, to prevent any meetings or conversations of this kind taking place at all. No one is obliged to speak to a Revenue Inspector in these circumstances. Ask them to put their questions in writing.

a winning case

One of our clients, an IT contractor, has just won his long-running battle with HMRC at an appeal hearing before the General Commissioners on the subject of his status under IR35 . Had the appeal been lost, a period of nearly 5 years would have been subject to the “deemed payment rule”. Under this rule, all company income from “caught” engagements have to be treated as if it were the personal salary of the worker and subjected to PAYE income tax and NIC. Our contractor client had been expecting an overall tax bill of some £60,000.

In Court, our contractor client was naturally very nervous and under cross-examination had to withstand repeated questions from the HMRC's advocate about discrepancies between his witness statement and a version of events given by a representative of the end client. The HMRC's advocate put it to our contractor client that:

•  He had exaggerated the features of his working arrangements to have characteristics of self-employment

•  The supposed right of substitution was “illusory”

•  In reality, the end client was able to control him in much the same way as if he had been their employer.

He put it to our contractor client that he was a Project Manager and was, therefore, in control of the end client's staff; so, it was not credible that the end client would have relinquished any rights of control over him.

Having given careful consideration to both the documentary evidence and the witness testimony, the Commissioners felt that a written right of substitution could not be displaced by the fact that it had not been exercised in practice. On the subject of integration into the end client's organisation, the commissioners pointed out that independence and isolation were not the same thing. The worker's position as part of the team did not affect the independence of his status. Moreover, he may have been a Project Manager, but he was not a line manager.

in summary

Readers who can put two and two together will have spotted that, if you can get around the IR35 problem, the opportunities for planning are just as great as ever they were before 2000. That is:

They are a lot of people reading this article paying huge sums in NI unnecessarily, merely by constituting themselves as employees (often directors or, indeed, sole directors) when, in fact, there is no one to whom they are in any way subordinate in the way they actually do their job. Do not volunteer to pay the government more than you need to!


Questions can be addressed either by letter or by email to: ‘Ask The Accountant, c/o The Editor at intouch (email: intouch@taceurope.com). We regret that we are unable to respond to unpublished letters and, in order to facilitate publication, letters may be edited. International Tax Solutions is a specialist, regulated, international tax firm providing free advice to expatriate consultants wanting to contract overseas and requiring compliant, practical and highly tax efficient solutions. You can call them on 020 7477 2660. International Tax solutions, TAC Europe and their respective employees cannot be held responsible for any actions undertaken as a result of the opinions expressed in this feature. As individual circumstances vary, you are advised to seek individual expert advice.