Being inside or outside IR35 is not a black and white issue. Estimates are that 20% of contractors are definitely inside IR35, 20% are definitely outside and the rest are in a grey area in the middle. You can new see why it is difficult to determine IR35 status.

How can contractors determine if they are caught?

The law for tax and social security legislation does not define 'employment' and 'self-employment'. Over the years Courts have considered the issue and their guidance on this issue is known as IR35 case law.

What happens if you are caught?

If you are “caught by IR35”, then all fees are considered “deemed salary” through your PSC and Tax and NIC will need to be deducted similar to an employee.

The financial impact of IR35 is significant for the contractor, since those caught by IR35 pay significantly more tax. A contractor caught by IR35 will typically receive 20% less in their pocket each month than a contractor who falls outside IR35. For a contractor on £40 per hour this equates to around £800 per month.

How to Determine If Your Contract Passes IR 35

Being caught by IR35 could cost you thousands of pounds, and thus the process of IR35 contract review before signing a contract is of paramount importance. Whilst the written contract is the most important factor for IR35 compliance, there are other IR35 criteria that are often overlooked. IR35 is a very complex subject.

Point 1: Background The background factors that could affect your IR35 status:

What is the background for obtaining the work? Did the job advertisement want a self-employed contractor or an employee? Are you replacing an employee? When replacing an employee, it’s likely you’ll be expected to be an ‘employee’ also. Check if you are replacing an employee or another contractor before you start.

Point 2: Previous Status Ruling Has there been a previous ruling by HMRC?

They may have previously decided the work is that of an employee and not a self-employed contractor. You may not be aware this decision has already been made and even if you ask the client they may not tell you due to confidential reasons.

Although these first two points do not relate directly to a contract, these points could mean that your contract may not pass a challenge from the Revenue.

Point 3: Contract This is one of the most important considerations in determining a contractor’s status. A genuine contract is based on the individual conditions that you will work to. If you have been given a contract by an agency or copied a contract from someone else then you could be in danger from a Revenue review. Revenue auditors will try to discredit a contract if they feel it isn’t a genuine contract. This can be done by selecting a clause in the contract; say for example a substitution clause and asking for evidence it has been invoked.

Often it hasn’t been invoked, so it is easy to imply that the contract isn’t genuine and the clauses have been copied from elsewhere. All the clauses must be genuine and you must be prepared to argue with the Revenue that they are.

Point 4: Mutuality of Obligation The mutuality of Obligation is important, and any contract should include this point. You should consider what would happen if you were offered work elsewhere. Would you be able to leave the present client and go and work elsewhere at the same time, or would the present client object? If your contract allows you to work elsewhere at the same time then this is a pointer towards self-employment. If the client refuses to let you work elsewhere then this points towards an employee. If there is no clause in the contract, then you should include one as a matter of urgency.

Point 5: Control If the client has control over your working conditions, it’s more likely you will be classed as an employee. Thus, the contract should not have any control.

Clauses to avoid are:

Time you start and finish each day

Days you are expected to work

Times you can take your lunch.

These are pointers towards employment.

 Any contractor who wants to be outside IR35 will need to ensure they can organise their work and the days they work rather than the client.

 Point 6: Substitution You should ensure there is a clause in the contract allowing you to send a substitute if you are unable or unwilling to work at any time.

 This must be a realistic clause, so you should ensure you know of a number of other contractors who are skilled enough to undertake the work for you, if you are unable to work the contract yourself.

 If you have no substitute arranged, the Revenue will assume you are “a disguised employee”.

 Point 7: Financial Risks If your contract allows you to be paid the same amount per month from the same client then it can give the impression that you are paid similar to an employee.

 A self-employed contractor is more likely to be paid on an irregular basis on production of an invoice when certain stages of the project work are completed. Regular monthly payments often indicate employment.

 Point 8: Equipment If the contract stipulates that all the equipment is to be provided by the client, then the Revenue often argue that the contractor is a disguised employee. This is not one of the main pointers generally in arguments with the Revenue. There are many tax cases which disprove this point, but it is a good idea to ensure that there is a clause regarding equipment and if there is a clause confirming what equipment you will provide.

 Point 9: Part & Parcel of the Organisation This term relates to whether the contractor has spent so much time at the client that they are integrated into their business. You will need to ensure that you are not considered part of the client’s business.

 You should have your own business cards and not be shown in the client telephone directory. You should not be part of the management team and there should be no reporting on staff. In effect, you need to distance yourself from the client and not appear to be integrated into the client business.

 Point 10: Intentions of the Parties It is worth making it very clear in any contract, that the agreement is one of client and contractor, not of employer and employee.

 Conclusion

 These points are important to ensure that your contract allows you to work outside IR35 and continue to receive your fees without any deductions. Failure to address these IR35 criteria in any contract will leave you open to a Revenue investigation and maybe all future payments being liable to income tax and National Insurance before you receive your fees.

Keeping Control Keeps IR35 Away From Contractors

Who runs your company? Who makes the decisions?

The issue is crucial to deciding whether you have a right to the privileges that come with a limited company. i.e., earning dividends instead of salary or whether you are caught by IR35 and related legislation like the managed service company rules, and are taxed like employee.

The issue of control is one of the key determinants the courts use to decide on whether or not you are an employee. It's easy for contractors to respond that they have control of the limited companies they have created to run their businesses. But it's not really that simple. After all, contractors probably have accountants who handle the administration for their companies. Contractors work with agencies who find work for them, and who often decide the terms used in the contracts.

 Are you an Employee?

 So contractors may own their own companies, but how much decision-making do they actually exercise? Is the client, through the agency, telling you when to work, how to work, where to work? Should it become obvious that you are simply behaving like a regular employee for a given company, but are being paid like a contractor, the Revenue will not accept your status.

 The definition of who is an employee and who is not depends heavily on case law. The courts are usually being asked to provide a worker with benefits under the Employment Rights Act of 1996. The courts will refer to a series of landmark decisions, including James v Redcat Brands Ltd. in 2006; to Brook Street Bureau v Dacas in 2004; and to Cable & Wireless v Muscat (which supported the decision in Dacas).

 Contract for A Service, Not for Work

 All of this case law shows that who controls whom is a crucial factor in making the determination. Your contract should show that your company, not you yourself, are providing services. You should have a right of substitution clause and be able to substitute another person at your own expense who can provide the services instead, and the client should not have the right to refuse your substitute.'

 Client Does Not Approve or Disapprove

 Your contract should state the terms for the services that your company provides, but should avoid any mention of personal service. It is not you yourself the client wants. The client wants an action performed. Your company decides all the rest. Nothing in the contract should suggest that the client can approve or disapprove of your actions, your means of performing the action the client requires, as the client might for an employee. Unless the means of performing the action is directly related to the outcome, the client should have nothing to do with it.

 Finally, you should show that you have the right to refuse further work from the client. You are not obliged to turn up at the client's office every day and just work at what is assigned. You pick and choose your assignments: you accept one, perform it, and then choose whether or not to accept another.

 These are, of course, basic principles on which contractor contracts should be written. The details are very important, and you should ensure that your contracts show that you are in control of your own company. The courts will look hard at the wording.

 Neglecting this issue could prove costly. The financial impact of being caught by IR35 is significant. If the Revenue attacks you, and the courts support them, you could wind up with a very heavy bill in back taxes.

Case Law

Case Law can be very useful but in many situations it is contradictory. Care should be taken in basing a decision solely on Case Law.

Express & Echo Publications v Tanton [1999] - Court of Appeal decision. Because the driver in the case had the right of substitution and he invoked this right he was found to be self-employed as such a right is not consistent with a contract of service. Advisers should be aware that this case is limited in its application to all situations.

Carmichael v National Power Plc [1999] - House of Lords decision. Recent finding that mutuality of obligation is vital within a contract of employment. Guides who worked on a "casual as required" basis were deemed to be self-employed. National Power was under no obligation to offer them work and the guides were free to accept or decline any work that was offered to them.

Smith & Chanton Group v Costain Ltd [1999] - EAT decision. The Tribunal found that, because of (a) the method of payment, (b) previous treatment as self-employed by the Inland Revenue, (c) the relationship was not permanent, (d) the worker was not issued with a disciplinary code, received no holiday pay, or pension and (e) there was no provision for notice, that a worker- working through an agency was not an employee of the client.

Chen Yuen v Royal Hong Kong Golf Club [1998] - Privy Council decision. A golf caddie who was free to work as and when he pleased was found to be self-employed because there was no mutuality of obligations.

McManus v Griffiths [1997] - High Court decision. The Inland Revenue successfully argued that despite the fact that the worker provided no equipment or premises to perform the work he was nonetheless self-employed.

Hall (Inspector of Taxes) v Lorimer [1994] - Court of Appeal decision. A vision mixer in the television industry was held to be self-employed even though he used the clients equipment and carried out his work from their premises.

McMenamin v Diggles [1991] - High Court decision. A barrister's clerk who was contracted to provide full clerking services to a set of chambers who had previously employed him was held to be self-employed. Although he took up the position as Head Clerk he had a genuine business and the right to provide a substitute for this position.

Bhadra v Ellam [1998] - Court of First Instance. A doctor with several locum jobs was held to be employed. The case considered the element of control and its relationship with responsibility. 

O'Kelly v Trusthouse Forte Plc. [1983] - Court of Appeal decision. A wine waiter who worked often but not regularly at functions as and when they occurred was held to be self-employed. The prominent focus to the case was the consideration that the arrangement was on a casual basis with no mutuality of obligation arising between the parties. Little regard was given to the fact that the work was carried out on the client's premises using their equipment.

Swan Hellenic Ltd v Secretary of State [1983] - High Court decision. The Court found that even if subject to a considerable degree of control a person can nonetheless be an independent contractor. In addition to limiting the importance of the control test this case highlighted the importance of the intention of the parties.

Massey v Crown Life Insurance Co. [1978] - Court of Appeal decision. Indicates that if an evaluation of the overall effect of the relationship is evenly balanced then the original intention of the parties may decide the issue. In this case the parties both agreed initially that it was a contract for services and he was held to be self-employed.

Ready Mixed Concrete Ltd v. Minister of Pensions & NI [1968] - A lorry driver had to wear a uniform and was subject to a significant level of control. However the van driver did provide a substitute. The driver was held to be self-employed because of this and the other factors inconsistent with a contract of service.

Market Investigations Ltd v Minister of Social Security [1968] - Court of First Instance decision. The case proposes that the question to be addressed is "is the person who has engaged himself to perform these services performing them as a person in business on his own account?" A positive answer to this question could imply the existence of a contract for services. What the case law indicates is that it is impossible to apply one single test. What is important is the picture painted by the overall results of the many tests applied. We have been unable to locate any definitive case law that indicates payment by the hour or a requirement to keep records of time amounts to a contract of employment.

 If you have any queries please do not hesitate to contact us.