Providing services to companies through a contract instead of being an employee can have tax advantages. Ltd companies set up to allow individuals to provide services to companies are known as personal service companies by HMRC. In 2010 HMRC enacted IR35 legislation with a view to obliging contract workers to pay taxes equal to employees if they are deemed to fall inside IR35 (See our blog for latest IR35 news).
The legislation, which has been criticised for lacking clarity, sets out criteria which will determine if the individual is to be taxed as an employee of the client or if the limited company is genuinely providing services as a third party. The main questions that need to be answered when considering IR35 are as follows. These questions should be addressed during the provision of service and when agreeing on a contract at the outset of the engagement.
Key IR35 Tests
- Control – What degree of control does the service provider have over the services provided. Can they determine how, when and where the services will be provided? A self-employed individual will be given a contract to deliver or advise on something. An employee, on the other hand, is likely to have less flexibility as to when and where the task should be undertaken or so the thinking goes.
- Mutuality of Obligation – This taken to mean that there is an obligation on the employer to provide additional work after the current work being undertaken is completed. There is an obligation on the employee to complete the work they are asked to do. This can be complicated as there will be elements of mutual obligation present in many contracts at various points. One key thing to bear in mind here when drafting a contract is to have clauses that will allow the service provider to walk away before the contract is complete.
- Provision of Equipment – does the employer provide equipment to carry out the work? If the service provider also provides their own equipment to carry out the work it will help to distinguish them from employees.
- Financial Risk – It would be unusual for an employee to take on any financial risk. HMRC will consider this so it can demonstrate any financial risk that the contractor has taken on to deliver the contract.
- Right of substitution – This is a key one as it can really help to demonstrate a case that a contractor is outside of IR35 if they are able to and actually do send alternative people to carry out part of the contracted works.
- Exclusive Services and Lenght of Engagement – It is typical for self-employed people to provide services to more than 1 client at a given time. As a result, any contract should specify that the contractor is allowed to take on concurrent contracts.
- Part and Parcel of the Organisation – contractors should not avail of the benefits that go with being an employee of the company. Some examples of things to avoid would include attendance at the Christmas party, availing of reduced gym memberships, bonuses or pension benefits. The contractor should not be subject to annual reviews and a disciplinary procedure.