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Section::IR35

Rationale
IR35 was a hastily conceived proposal aimed at raising revenues by attacking what the Government perceived is a soft target: a group of disconnected individuals (contractors). However, IR35 has to proved counter productive for all concerned: contractors, agencies, accountants, clients engaging contractors and the Government.

IR35, although getting muddled, appears to be squarely aimed at contractors trading through own limited companies. This is because the drawing of dividends attracts no liability to National Insurance (something the Govt. wishes to prevent).

If you are uncertain about your status and wish IR35, Section 660 or general Employment Status Advice, we are able to offer advice on these matters with the the back up of Bauer & Cottrell  So if you wish to have a contract reviewed ... you know where to come.

Assumptions

1. IR35 states "....Government’s commitment to achieving a tax system under which everyone pays their (sic) fair share" and "....consultant paying substantially reduced tax and national insurance".

Do we have a Government finally admitting that NI is merely another tax? Anyway, our contention is that for a given salary/gross contract income, a contractor working through his/her own limited company pays virtually the same tax as a traditional employee.

Salary/gross contract income	Traditional employee			Contractor, Ltd Co.
	net income	NI	total tax	total tax	net income
15000	11410	1500,1234	2356	2520	12480
20000	14670	2000,1734	3506	3570	16430
25000	18110	2500, 2234	4656	4620	20380
30000	21938	3000, 2256	5806	5670	24330
40000	28158	4000, 2256	9586	9179	30820
50000	34158	5000, 2256	13586	13254	36745
100000	64158	10000, 2256	33586	33629	66370

• NI shows employer and employee respectively
• assumes contractor draws £3000 salary, balance as dividends thereby avoiding any NI
• 1998/99 rates used because assumed these were the figures used in the original Govt. assessment of £475m lost revenue

Any prospective contractor must be looking to receive a gross contracting income at least 40% greater than any salary he/she earned as a traditional employee. Why? Factor in the following costs: pension 10%, sick pay 2.5%, holiday pay (Working Time Regs.),  employer NI 11.8%, employee NI 10%, private medical insurance, company car, travel, training, telephone, light, heat, accommodation, equipment/tools etc. Of course, using the Ltd Co. route, the NI is optional but the benefits that NI provides then have to be paid for (else forgone) privately at the same cost: that is unless the Government is going to argue that NI does not provide value for money.

OK. There can be no argument that on a gross basis  a contractor does (must) get paid more than a traditional employee for the same role. Examine the case if this income is 40% more (as per our minimum recommended starting point):

• Contract income = salary + 40%
• NI includes employer and employee
• Other assumptions as before

The inescapable conclusions are:

1. For equivalent gross incomes, contractors working via a one man limited company pay virtually the same tax (often more)as the equivalent traditional employee (Table 1)
2. In reality contractors get paid more gross for the equivalent traditional employed role. Thus, even using a +40% minimum criteria, all contractors pay more tax contrary to IR35’s assertion of "substantially reduced tax" (Table 2)
3. Following on from this, the higher tax even exceeds the sum of the traditional employee’s tax and NI.
4. Even if we include employer’s NI, the contractor’s tax paid exceeds the total at higher contracting incomes (crossover between £40000 and £50000). This point should be irrelevant since IR35 (Details 1) states the objective as "pay the same tax and NI as someone employed directly" and not "as someone employed directly and the employer too".

It seems more likely that IR35 will reduce Government revenues contrary to the purpose for its existence. However, let’s look at some other factors.

2. Not all contractors work through a "one man limited company". Those working as PAYE for an agency have no scope to reduce NI let alone tax. Therefore, given the higher rates of income, the Government revenues generated must be higher.
3. Umbrella companies: many contractors working under one limited company. In few cases are contractors shareholders within these arrangements. Therefore, once again, there is no scope to reduce NI or tax because all income is PAYE. Conclusion: higher gross income = more tax and NI.
4. IR35 (Details 3) states "no intention to redefine the existing boundary between employment and self-employment". This is a somewhat bemusing assertion:

• there are probably no contractors within IT working on a self-employed basis although there are some within engineering. Therefore, what is the relevance of that particular statement? The Revenue appears as confused as some accounting firms over what self-employment is: it certainly isn't working through a limited company.
• anyone working via a limited company is almost certainly an employee of that company. Those working via agencies or umbrellas are also employees. Therefore, if you are an employee, how can you be in "disguised employment".

The scope for tax and NI avoidance via self-employment cannot be the issue because contractors are rarely self-employed.

Practicalities
How can the aims of IR35 be effected in any practical manner?

1. In the past it has been difficult enough to distinguish between the employed and self-employed: witness 714/SC60s in construction. Given that the vast majority of contractors are already employees, even if it is with their own companies. So the Revenue has effectively created a new category of employment.
2. Is there a legal basis for IR35, particularly within the framework of the EC?

Unsurprisingly, the onus of proof and administration (collection and payment) has changed from the client to.... yes the Contractor. Get it wrong in your favour and you will be heavily penalised. Get it wrong in the Revenue's favour and.... they'll keep quiet?

Effects
The effects of IR35 should be patently obvious to all.

1. The UK is amongst the world’s leaders in IT and engineering expertise but IR35 will result in a mass migration overseas. Labour precipitated a brain drain in the 70s from which we have just recovered. Is "new" Labour  to do the same? There are Contractors now fleeing to the EC or refusing to Contract at all.. By the very nature of their work, contractors are used to upheaval and occupational mobility and so stepping across the channel is no big deal.
2. What about the multiplier? This is the economic mechanism whereby money spent feeds back though the economy to have much greater effect than the initial spend. Contractors’ higher incomes feed back through the economy many times over and also support a whole (if not wholesome!) industry of agencies and accountants.
3. We don’t foresee IR35 being a major vote winner:

• amongst the real abuses of tax and NI are "self-employed" direct sales forces: Allied Dunbar, Prudential, Everest, Möben etc. By taking all income as commission, they avoid employment status using the loophole of non-surety of income. If tax avoidance is really an issue then this has to be a far more valid starting point: or do these companies have more lobbying power than unconnected individual contractors?
• why are accountancy and solicitors' partnerships not affected?
• the accusation of "Tony’s cronies" is going to be levelled. The biggest beneficiaries of IR35 will be Accountants and the big Consulting companies of this world. Further, we doubt the users of contractors will thank Mr Brown for forcing them to pay the kinds of rates charged by these organisations

Conclusion
Of course, the honest thing to do would be to eliminate NI and add it to the tax rates. This would simplify the tax system, reduce bureaucracy and save £millions from people pushing bits of paper around in Newcastle. The downside is that Labour would then be unable to claim we have the lowest tax rates in Europe.

If you are going Contracting you must familiarise yourself with the rules and their workings. 
There are grey areas and so you must optimise your chances of escaping. 
To that end you can do little better than to visit and join the Professional Contractors Group

IR35, Section 660 and Employment Status Advice