Personal Service Companies and IR35

Vanessa ChallessAll Factsheets, Business, Company Law, Factsheets2

Why IR35 was introduced

For a number of years it was common practice for individual contractors to supply their services through an intermediary, typically a personal service company, with income being paid via dividends which are not subject to PAYE and NICs. The IR35 legislation was introduced to enable HMRC to deal with those situations where the sole purpose of an individual’s intermediary arrangements was to avoid liability for income tax and NICs. The IR35 legislation allows HMRC to look behind the intermediary service company.

FACT: there is a common misconception amongst contractors that IR35 only applies to IT consultants. Not true. The case law changed so that they were specifically included.

Do the Regulations apply?

Broadly, the Regulations apply if the three following conditions are met:

• An individual personally performs services for a client (or is obliged to do so).

• Those services are provided under arrangements involving an “intermediary”.

• If it were not for the intermediary company, the relationship between the individual and the client would be one of employment.

Importance of an individual’s employment status

One of the key questions is whether the worker would have been an employee of the client if they had been working directly for it, if not, the IR35 rules will not apply.

Reducing the risk of IR35 applying

Both the contracts in place and the reality of the situation will be relevant to whether a particular arrangement is caught by IR35. It is equally important for both the written contracts and the reality of the situation to fall outside of the scope of IR35.

What contracts are in place ?

Of the two contracts, the one that is likely to get more attention in any HMRC investigation (and which is therefore the most important) is the contract between the intermediary and the client which should be a properly drafted contract for services, that is, it should be everything that an employment contract is not.

Contract with the worker

Although less important than the contract with the client, it is still important to put an employment contract in place between the worker and the service company which should look as close to a standard employment contract as possible.

WHAT IF IR35 DOES APPLY ?

Tax/NIC consequences

If IR35 applies, the sums received by the intermediary are effectively treated as employment payments by the intermediary to the worker for tax and NICs. So, you will be treated as if you were on a salary rather than the tax efficient dividends you so carefully set up.

No entitlement to NICs employment allowance on deemed earnings

Businesses are now entitled to claim a deduction of £2,000 from their liability to employers’ NIC. However, this does not apply to NIC on deemed earnings, that is, income derived via the intermediary that is deemed to have actually been a salary.

So, the main message is this: ensure you have the right contracts in place and ask a specialist to consider your situation in the round, there are no hard and fast rules.

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