IR35 Myths

IR35 will affect your earnings and it should be a major factor in deciding whether you form your own company (Personal Service Company or PSC) or work through a PAYE Employment Services Company (Umbrella Company). 

If you choose a PSC solution, the difference between being ‘inside' or ‘outside' IR35 can affect your take home pay by as much as 20%.  Choosing an Umbrella solution removes the need to comply with IR35 legislation as you are an employee and will be subject to normal PAYE rules and regulations. 

However there is considerable misinformation circulating regarding IR35. We have listed our top ten myths to help you understand the actual legal position: -

• There is a way round being caught by IR35 legislation

The fundamental premise of IR35 legislation relates the actual, real, relationship between contractor and client and any number of dodges, third parties, contractual clauses and representations can't hide the facts.  If the working relationship between contractor and client would be normal employment, if it were not for the existence of an intermediary, then the contract is subject to IR35 and resulting tax and NI payments.

• Nearly all Contractors are caught by IR35

The HMRC will say that most contractors will be caught while others will say that all contractors can avoid IR35.  The application of IR35 depends upon the engagement and the individual contractor's business.  According to informed sources upwards of 50% of contract engagements are legitimately project based and are not be caught by IR35.

• I can use an IR35 ‘proof' contract approved by HMRC.

There is no such thing as an IR35 "proof" contract as all of the actual working arrangements are relevant.  Many so-called IR35 "proof" or "friendly" contracts are drafted without consideration for the real situation or the requirements of clients and agencies.  To avoid the contract or clauses being labelled a sham, contractors should ensure that contracts are professionally drafted, industry specific and truly reflect the relationship.  Individual contracts have been approved by HMRC in individual circumstances but HMRC have not given 'blanket' approval to any 'product', nor will they.

• IR35 decisions are entirely based on the contract.

Not correct, HMRC can look at all the working arrangements. In addition to the contract, the assignment schedule and description of the work will be considered.  Even if the contract contains all the terms associated with self-employment the work undertaken and the contractor's business practices and the actual working arrangements will also be investigated.

• The Client/Agency contract is not important.

This contract is relevant to HMRC and should ideally mirror the terms of the agency/contractor contract. Although the service company is not a party to the client/agency contract the IR35 legislation looks at the commercial relationship between the worker and the end client as evidenced by all of the contracts involved. It would be unwise to rely upon the agency as being interpreted as the client in the legislation.

• All you need to avoid IR35 is to be in business on your own account.

This argument, still put forward by some advisers, was run in the Tax Commissioner case of Synaptek -v- HMRC. The contractor failed despite there being plenty of evidence that he was in business on his own account. Any genuine business could be subject to IR35 if the working arrangements reflect a personal service that would be akin to employment in the circumstances set out in the legislation. In short trading through a PSC does not remove the risk of IR35.

• A substitution clause is all that is required

A genuine right of substitution is an important factor in determining self-employment status. However many attempts at including substitution do not take into account the relevant case law, the client's requirements and industry practice. There are important legal distinctions between assignment, substitution and sub-contracting that need to be taken into account and in the absence of actual substitution a clause may not be relied upon to keep the arrangements outside IR35.

• HMRC have the last word

• IR35 Legislation will be abandoned

The Finance Bill 2000 containing the IR35 clauses has been debated in the House of Commons and was given Royal Ascent on July 28, 2000. This was tested in Court by the PCG in its judicial review. The PCG lost. The government extended the legislation in April 2003 and there is little likelihood that the tax will be discarded. It is therefore important that contractors and accountants are aware of the options available and the best strategies