Service Companies (IR.35)

What Is Ir.35?

IR.35 is the reference number of a HM Revenue & Customs publication which details the rules now introduced to increase National Insurance revenue from Service companies.

The original proposals made public as long ago as September 1999 were widely condemned. Those proposals placed the compliance burden on the users of service companies. Those proposals were subsequently deemed to be unworkable and impracticable. They were dropped and a fresh set of rules were introduced initially via the Welfare Reform and Pensions Act and subsequently by Statutory Instrument. The rules that actually came into effect place the burden of compliance on the service companies rather than the larger companies that engage them.

The more cynical amongst us might think that small often one man companies are a much easier target than large well organised, well funded organisations with a much stronger ability to lobby Government. Whatever the reason the problem of IR.35 falls firmly on the service companies and their directors.

What Is A Service Company?

Generally speaking a service company is a limited company which exists to provide the services of one (or more) person(s) to another company or organisation. Typically such a company would have one director a Company Secretary (not actively involved in the business of the company) and one or two shareholders. In many cases, but of course not all) the Company Secretary is the director's wife and two shares are owned one each by the director and his wife. The business activity centres almost totally around the director who quite usually provides his services on an hourly rate, via his company to another company.

Services companies have become common place in a number of industries including:

  • Information Technology (Computer software designers etc.)
  • Aerospace (Maintenance, Manufacture & Design)
  • Television (from lighting technicians to the top of the scale)

Why Do People Use Services Companies?

The users of service companies do so (inter alia):

  • To be able to hire and fire without having to be encumbered by employment law protection and statutory periods of notice etc.

  • To avoid employers National Insurance Contributions

  • To avoid having to pay holiday pay, sick pay and for down time

The owners of service companies do so (inter alia):

  • Because they may not be able to get work as a direct employee (this is often the case in some of the industries mentioned above)

  • To provide a limit to their liability if things go wrong. Some risks are covered by insurance, but not all risks

  • To be able to exercise some flexibility over their tax and national insurance affairs. It was previously possible to drawn a small wage and top this up with dividends. There is no national insurance for either employers or employees on dividends. Also dividends are usually taxed at a lower rate (in the UK) than most other income.

What Is The Effect Of Ir.35?

The object of IR.35 is to prevent the flexibility of arrangement of tax and National Insurance affairs mentioned above. It does this by treating the employee (director) as having received a salary equivalent to most of the income from contracting work that the company receives. This increases the Governments revenue from tax, employers national insurance and employees national insurance.

The Government are the winners, the small business man is the loser.

The way the rules work, the director/employee might as well have the salary per the IR.35 calculation because he will be taxed on it whether he has it or not. Furthermore to deal with the company's finances any other way can accidentally result in double taxation which is not relieved.

How Do I Know If My Company Is Subject To Ir.35?

The gist of the test is....

  • If the limited company were not there would you be treated as employed by the contractor (for whom your company does the work)?

  • If the answer is yes then your company is caught by IR.35

The criteria used are the same as those for determining whether a person as employed or self employed. A table of factors below gives some guidance but remember no one factor alone will determine the outcome but will add to the overall picture to be considered.

For Employment

Against Employment

The parties agree employment

The parties agree self-employment

Control by another of the manner in which the work is performed

No control by another over the manner in which the work is done

The person performing the work is restricted from delegating his/her work to another

The person performing the work is free to delegate his/her duties to another

The person performing the work does not bear the losses nor keep the profits

The person performing the work bears the losses and keeps the profits

Tax and National Insurance contributions are withheld by the person for whom the work is done

No tax or National Insurance contributions are withheld from payments

The person for whom the work is done provides the tools and equipment

The person performing the work provides his/her own tools

The person for whom the work is done lays down regular and defined hours of work

The person performing the work is free to decide when he/she wishes to work

The person for whom work is done cannot withhold payment

The person for whom work is done is free to withhold payment until the work is performed as agreed,

The person for whom the work is done can dismiss

The person for whom the work is done cannot dismiss the worker or cancel the work once the work is agreed, without compensation

HM Revenue & Customs did at one time operate a service which enabled contractors to receive a ruling on their contract for these purposes. You could send your contract to HM Revenue & Customs, or email it, for a ruling but there were some provisos:

  • The contract must be signed and dated and

  • Full details of the company, its' Corporation Tax Reference number and postcode must be supplied.

More details on the current position may be found on the HM Revenue & Customs web site: http://www.hmrc.gov.uk/ir35

Can I Get Out Of Ir.35?

Some people are suggesting that a tightly worded contract will exempt you from IR.35. Some will even sell you a contract that might fit the bill.

BEWARE! This is not a magic answer.

HM Revenue & Customs have said that if what a contract says is not what actually happens in fact, then they will disregard the contract. This is the case even if HM Revenue & Customs have examined the contract and given a decision that it is one of self employment not employment.

Over the past years how vigorously HM Revenue & Customs pursued IR.35 has varied. Their expectation must have been that is that it would provide an easy picking ground for them to gather extra revenue for the Government in terms of both tax and National Insurance.

How Is The Salary (or deemed salary) Calculated Under Ir.35?

The basic calculation follows this format:

Total Income from relevant engagements

£           

(TI)

Less:

 

 

Salary and employers NIC paid

£

Expenses allowable under S.198 TA

£

Pension contributions (approved)

£

Cash equivalent of benefits in kind

£

Other Statutory allowables for employees

£

Capital allowances claimable by employees

£

5% of gross income figure

£

Total of above Expenses

£

(TE)

Total Income less Total Expenses

£

 

Employers National Insurance as a proportion of TI-TE

£

Deemed salary before Tax & employees NI

£

(DS)

What Is The Deemed Salary?

The deemed salary is the amount that the director/employee will be taxed on regardless of whether a smaller salary has been paid. If the actual salary is bigger than the deemed salary (this is unlikely) then the actual salary would be taxed.

Payment Of The Deemed Salary

The company does not have to pay the deemed salary to the employee/director concerned, but when it is eventually drawn no further tax or NIC will apply.

However, it is likely that the salary will be paid for the simple reason that otherwise no deduction for Corporation tax will be available and there will be insufficient funds to meet the tax payment.

A deduction for Corporation Tax is available for all payments to directors which relate to a particular year’s profits and which are paid within 9 months of the end of the accounting period.

Exempt Employees

Where an employee has no right to income or capital from the company (subject to a small exemption for employee share schemes) and receives no income in a form not subject to Schedule E tax (PAYE), he/she will be outside the scope of these rules and therefore no reconciliation will be necessary, even where all of his/her work constitutes relevant engagements.

Such a position must be bona fide and not artificially created as anti avoidance provisions apply.

We understand that for the purposes of these provisions a common law spouse will be regarded as an associate for taxation purposes.

For information of users:
This material is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by the authors or the firm.