IR35 - everything you always wanted to know but were afraid to ask
Created | Updated Jan 15, 2003
Introduction
This Guide Entry contains advice given at a series of briefings during May 2001. Square brackets enclose supplementary information.
For readers new to this subject, if you don't know what IR35 is, you don't need to know. For those that do know - read on.
It is not the object of this Guide Entry to debate IR35. A search on the Internet will facilitate unlimited access to that. The Inland Revenue (IR) and the Professional Contractors’ Group (PCG) provide an abundance of information to enable an assessment of accountability to IR35. It is not the purpose of this Guide Entry to discuss that either.
P35
IR Form P35 is the starting point. P35, Q6 asks: Do the rules relating to payments for services provided through a Service Company or a Partnership apply to any of your business income?
The contractor should tick the ‘No’ box.
Contract
The contract should be ‘appropriately worded’. [Most agents know what this means and will readily comply; many do it now as a matter of course. Further information on this is available on the PCG web site. See The Low Tax Group and other sites for advice on contract wording.]
Web site
The contractor should emulate established public limited companies and set up a professional looking web site. The existence of a company web site will help support claims that the contractor is a real limited company and not an employee of his/her client.
Advertising
The contractor’s services should be advertised from time to time in appropriate trade journals. This too will help support claims that he/she is a proper limited company.
IR audit
The IR is grossly under-resourced. [There are roughly 70 000 tax inspectors responsible for some 40 million taxpayers, ie, one inspector per 600 taxpayers.] Therefore, the risk of an audit by the IR is low. This fact is of crucial importance and underpins the entire strategy.
Whilst the risk of an audit may be low, it could happen. However, provided the contractor has taken precautions as outlined in this paper, if the worst happens he/she will be able to argue that non-compliance was an honest mistake; in these circumstances penalties are unlikely. If, however, the contractor has been sloppy in the management of his/her affairs such an argument will be impossible to carry and penalties are very likely.
Forward planning
The trick is to have the right words in the contract, have a business web page, advertise for work and generally conduct oneself in ‘a business-like manner’. The contractor should set himself/herself up like a real business, think and act like a real business - but be prepared.
Financial management
The contractor should calculate what his/her tax liability would be under IR35 and put to one side the difference between that and the tax he/she actually pays. There will then be no difficulty paying the IR in the event of an adverse audit. [Note that in this context, tax means PAYE, employer’s NICs and employee’s NICs.]
An IR audit is limited to the previous 5 years. Therefore, after 5 years the contractor can safely spend the money set aside in the first year. After the 6th year the contractor can safely spend the money set aside in the 2nd year and so on.
Benefits
[The potential gains are considerable. The writer is on a relatively modest £35 per hour. Under IR35, tax would be around £12000 per annum. Outside IR35, tax would be around £2000, a difference of £10 000 per annum. The calculation assumes a salary of £1000 per month, 37 hours a week for 40 weeks and reasonable allowable expenses. See IR35 Calculator for more information. By 2005 the total set aside will be around £50 000. The figures speak for themselves.]
