IR35 Factors, IR35 Compliance, are you caught?

Following the Chancellor's decision to maintain the IR35 status quo at the last Budget, we take a look back at how the intermediaries legislation came into being.

In the beginning...

On 9th March 1999, The Inland Revenue (HMRC) published a press release - "IR 35" - which detailed Gordon Brown's plans to create legislation to "counter avoidance in the area of personal service provision."

The Government said it had been concerned that people who were performing work in the manner of a normal company 'employee' were setting up their own limited companies and continuing to work in the same way, but paying less tax and national insurance by virtue of their new service company structure.

After a consultation period, the Inland Revenue issued a second press release outlining how the intermediaries legislation would work.

The revised proposals included details of the deemed payment 5% expenses allowance which would apply to people caught by IR35, guidance on how to determine a worker's employment status were published in leaflet IR56, and a statement that service companies themselves were responsible for "operating the legislation", not clients.

IR35 becomes law

'IR35' became law in July 2000 via the Finance Act - with Schedule 12 containing details on IR35 itself.

In essence, the tax rules were created to prevent people who would ordinarily be viewed as 'employed' by HMRC from being taxed as if they were 'self employed'.

An IT worker might leave his permanent job one day, only to return the following week as a contractor working via his own limited company - doing exactly the same work as he did before.

In this example, the contractor would be paying less tax and national insurance (NI) as a proportion of his income than he did as a permanent employee. This is precisely the type of scenario that HMRC has been targeting with the IR35 legislation.

"It is possible for someone to leave work as an employee on a Friday, only to return the following Monday to do exactly the same job as an indirectly engaged 'consultant' paying substantially reduced tax and national insurance."

The fight against IR35

The IR35 rules have been widely condemned since they were first announced a decade ago.

The Professional Contractors Group, which was created to fight IR35, received permission for a judicial review of IR35 at the High Court. On 2nd April 2001, the court found against the PCG.

The PCG petitioned the Court of Appeal, who heard their case in early December 2001. The appeal was dismissed on 21st December 2001, and permission to appeal to the House of Lords was refused. IR35 has remained law to this day.

Since 2002, the PCG has concentrated on its IR35 case law strategy, and protecting contractors and freelancers against the punitive tax rules.

Simplification of IR35?

Hopes were raised following the election of the Coalition Government to power in 2010. One of its first announcements was the creation of the Office of Tax Simplification (OTS), which was tasked with reviewing the way small businesses are taxed - including IR35.

Its interim report into IR35 was published in March 2011, prior to the Budget.

Three proposals were put forward - the suspension (and eventual abolition) of IR35, the introduction of new 'genuine business' tests, and a maintenance of the status quo but with improved HMRC administration of IR35.

The Chancellor decided to keep IR35 in force, as abolition could result in a significant shortfall in Treasury NIC receipts - primarily from umbrella companies.

A new specialist helpline has been proposed, and better guidance is to be produced to remove the uncertainty created by the IR35 rules.

More announcements are expected to follow later in 2011.