Look to ClearSky for IR35 advice
25/08/2009
LOOK TO CLEARSKY FOR IR35 ADVICE
No single issue has caused as much uncertainty and discussion in the world of contracting as IR35. A 2008 survey[i] estimated that around two thirds of contractors put themselves at risk from owing thousands of pounds in employment taxes by not having their IR35 status properly verified. In this current economic climate greater numbers of workers are moving in and out of contracting making it more important than ever that freelance workers seek trusted, reliable advice.
In this article, Duncan Strike, founder and managing director of ClearSky, an accountancy firm that has provided specialist services to freelance workers and contractors for 12 years, examines the factors which help establish a contractor's IR35 status, stressing the importance of the day-to-day activities. In addition, he also offers a number of recommendations to help contractors avoid having to pay out substantial amounts in penalties, back taxes and interest as was seen in 2008 with the Dragonfly[ii] case, where an IT contractor had to pay back £99,000.
Fait accompli
There is widespread disagreement about the need for IR35. The Professional Contractors Group (PCG), a body which represents the freelance community, believes that the legislation "seeks to deny that freelance contractors are genuinely in business and to tax them as employees without establishing a proper employment relationship." PCG also recently asserted that the legislation was a waste of time because to date it has only brought £9.2m[iii] to the Treasury, equivalent to just £1.5m for each year the legislation has been in place. However, income measured by HM Revenue and Customs (HMRC) as directly attributable to IR35 is only likely to show a very small part of the overall picture. This figure does not consider the amount generated by contractors working through umbrella companies (companies that provide employment services such as contracts, HR support, invoicing and timesheet management for contractors), which represent a more simplified employment model than the limited company option but at the same time can limit a contractor's income.
However, while the legislation remains in place, contractors are under an obligation to operate within the law, and there are a number of experienced firms, such as ClearSky, who offer regular assessments and tailored advice to ensure they are operating compliantly. Contractors who ignore IR35, whether deliberately or not, are at risk from a significant penalty and interest regime that could have very serious financial implications.
Status quo
Despite the confusion and dislike of IR35, every contractor needs to consider their status and take any necessary action. However, the legislation does not apply to all contractors. Current unofficial estimates state that around 20 per cent of contractors are affected by the legislation, or deemed to be ‘inside IR35', 20 per cent are definitely outside and the rest are in a grey area in the middle. Determining whether contractors are affected by IR35 is complex and can change during the lifetime of a contract and is why contractors need to seek reliable advice from a trusted IR35 expert.
No small change
As well as the legal requirements, the financial aspect of IR35 is key for contractors, since those deemed to be ‘inside' the legislation will pay significantly more tax. A contractor caught by IR35 will typically receive 20 per cent less in their take-home pay than a contractor who falls ‘outside'. This equates to around £800 per month for a contractor earning £40 per hour. No one wants to pay more than the correct amount of tax and national insurance liabilities.
IR35 assessments should consider a wide range of the contractor's circumstances including the written contract between the contractor and the end-client. Certain clauses or phrasing could actually be harmful e.g. contractors may want to avoid clauses that set out the days and hours they must work, and when they should take breaks. The history of the contractor limited company needs to be taken into account in terms of how it is run and whether it is truly run as a business i.e. does it have a website or own company stationery or does the contractor provide his or her own tools to undertake the task. Another factor to consider would be the nature of the skill being provided and whether it is unusual in the nature of the end-client's business. One of the most fundamental areas of the assessment is the nature of the day-to-day relationship between the client and contractor, and whether this can be defined as employment or self-employment.
Defining self-employment
What IR35 seeks to do is look at the manner in which a person provides their skills and to see if the provision of services is as an employed person or as a self-employed person. There are three major factors which, although not exhaustive, must be considered during an assessment of IR35:
Control / independence - how much control does the contractor have in influencing how the project is run? Can they make decisions about timing or what equipment to use? Even a senior employee who may have substantial control over his or her own work will always be subject to some control from his or her employer. If control of this sort is absent or minimal then we are not looking at employment and IR35 cannot apply.
Personal services / subsititution - is the end client specifically seeking the skills of the individual or could another person be sent in their place to provide the service? Services which are, or can be, provided by more than one person are not personal services. IR35 legislation is set out in terms of a person being under an obligation to personally supply services.
Mutuality of obligation - is there an obligation that the individual will be paid whether there is work or not? An employee would be expected to accept work and the employer to pay. If you were self-employed and there was no work you would be sent home and would not be paid. Absence of a sufficient mutual obligation means that IR35 cannot apply.
Tricky business
As with any law IR35 is subject to interpretation. One person's view of the facts, and how the law applies to those facts, will differ from another's. Laws also evolve and can lead to a certain conclusion but if the interpretation of the law changes by precedent, those same facts may produce a different assessment at a later time. Furthermore, the facts are subject to two parties' differing views of the facts i.e. do the contractor and client agree on the details?
Day- to-day detail is necessary
Capturing the details of the actual day-to-day working relationship between the contractor and the end-client is critical. To this end, ClearSky's team of six IR35 experts spend significant time assessing their clients' business and conducting a thorough IR35 review. ClearSky Personal Accountants take contractors through some very simple provisional checks to establish whether they are "caught" by IR35 and whether the limited company option is right for them. Their accountants then conduct a thorough IR35 check on each contract to ensure contractors remain fully compliant with IR35 legislation. After six to eight weeks into the contract, ClearSky offer contractors a full and comprehensive assessment of their day-to-day working relationship with the end-client and have an out-of-hours service (telephone and email) to accommodate contractors working longer hours. For many contractors, customer service is as important a factor in choosing an accountant as price.
Forewarned is forearmed
One of the ways contractors can limit the extent of any investigation by HMRC is to ensure that they maintain an accurate record of every contract. By doing so, contractors could have enough supporting evidence to close down an investigation before it even begins. All contractors should keep copies of any emails that discuss elements of their contract; keep notes as to how they (not the end-client) made decisions about how work should be done on a project, issues of control, independence and the application of specific skills, as well as notes pertaining to important conversations and diarise events where contractual issues were discussed. Where possible, the end-client should sign these notes. Such an approach requires a lot of discipline from busy contractors but the potentially costly alternative leads many to acknowledge its wisdom.
Companies such as ClearSky maintain records on file for contractors who have been assessed so that should a contractor face an investigation accurate records can be found quickly. Contractors should officially record basic information such as the exact nature of the relationship between the contractor and the end-client. This should be updated whenever any changes are made. However, they should exercise caution in relying too much on the written contract because, when working on-site, many contractors and end-clients will mutually agree changes verbally. Even if subtle these changes can alter a contractor's IR35 status. Where possible, any alterations should be recorded or the written contract will quickly outdate.
File it
Without clear written evidence relating to a contractor's IR35 status HMRC can draw their own conclusions. In a typical investigation HMRC will request a copy of a contract from the end-user client with a list of specific questions and given that this request can be made up to six years from the end of a contract, it is likely that the personnel at the end-user client will have changed. Many of the answers given by the end-client are not specific to the actual contractor, rather these relate to what is thought to be a ‘typical' client-contractor relationship, which may not bear any resemblance to the specific situation.
It is therefore crucial that any company assessing IR35 status keep every dated assessment and amendment on file so that they can be presented as evidence during an investigation or court appearance. This information could be the difference between no action being taken, and the contractor having to pay out substantial amounts in penalties, back taxes and interest.
Check the small print
ClearSky's service includes a full review of the contractor's circumstances in relation to IR35. This involves completing a full detailed review of the contractors working relationship with the end-client, examining the contract that exists and working closely with contractors to determine status and as far as possible providing the means to manage any associated risks. Any issues between a contractor and client which cause concern should be addressed whilst the contract is current, rather than retrospecitvely during the course of an investigation.
Dates to remember
IR35 reviews should be undertaken regularly but there a number of key points when they are crucial:
- whenever the contract is up for negotiation or renewal, even if this is numerous times
- when end of year P35 and PAYE submissions are made (this is also a crucial time for a contractor to declare if they are working ‘inside IR35')
- between the end of the tax year and the following 31 January, when personal tax payments become due, but it is recommended that a review is always completed before self-assessment personal tax returns are submitted.
Don't ignore it
Many contractors believe that HMRC's provision for IR35 is under-resourced and the threat of investigation minimal. However, this mindset and approach could backfire because HMRC is becoming increasingly targetted in its methods for discovering contractors working for personal service companies and earning substantial incomes. It can often be an unrelated investigation of a client that leads HMRC to approach individual contractors - who are not difficult for HMRC to find because they are obvious in the accounts of end-clients or agencies, or through declarations on the P35 or personal tax return forms.
One effect of IR35 has been to drive greater numbers of contractors into PAYE schemes, such as umbrella companies. If, however they were to seek expert advice on their contract status, many contractors would satisfy self-employment tests and confidently run their own limited company, thus increasing the ability to maximise their income. By adopting a number of simple strategies, such as keeping a basic record of facts, contractors can protect themselves in the future against any adverse effects of an IR35 investigation. It is also crucial for contractors to keep accurate records so that if they are investigated they have all the necessary information to hand.
ClearSky's transparent and tailored, monthly fixed-fee service includes trusted guidance and assistance with understanding the complexities of tax legislation and avoiding the pitfalls. By working with experts such as ClearSky, contractors can be assured that they will establish the correct IR35 status and at the same time maximise their income.
[i] Shout99 survey of freelance contractors for Brookson, 2008
[ii] The appeal in the landmark IR35 case, Dragonfly Vs HMRC left IT contractor Jon Bessell with a tax bill of £99,000
[iii] This figure was taken between the tax years 2002 / 03 - 2007 / 08
[iv] Freelance World, mystery-shopper survey of high-street accountants, 2009
