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IR35 was originally conceived to tackle the problems of tax and NICs (National Insurance Contributions) avoidance through the use of intermediaries such as service companies or partnerships. Largely it was to combat certain individuals from leaving their current employment, opening up their own limited companies and then contracting themselves back out to the same job. By paying themselves in company dividends and not in salary, they would avoid paying their NI and tax contributions.
WHAT WERE THE PROPOSALS?
23rd September 1999, to:
Place responsibility for complying with the new rules on the service company or partnership, rather than on the client; and use the existing tests used to determine the boundary between employment and self-employment for identifying contracts affected by the new rules.
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WHEN DO THE NEW RULES COME INTO EFFECT?
Announced by the Chancellor in his 1999 Budget speech, the rules came into effect on the 6th April 1999.
WHO WILL BE AFFECTED BY THE PROPOSALS?
Anyone supplying their services through an intermediary such as a service company or partnership will need to think about the new rules. If it is deemed that the worker could have worked directly with the client, and the advent of the service company was made in addition to requirements, then you will meet the needs of IR35.
WHAT IF I AM AUDITED AND THE IRD DECIDE I HAVE FAILED TO COMPLY WITH IR35?
The repercussions will be the same as if you failed to pay appropriate contributions for PAYE and NI as outlined in the Inland Revenue leaflet IR 109. IRD will seek to recover all unpaid taxes, plus interest and may prosecute if you are suspected of negligent or fraudulent conduct.
WHAT IS AN IR 35 APPEAL?
An IR35 appeal is an appeal against a decision of the Inland Revenue that payments made to intermediaries such as service companies should be treated as earnings of the worker for the purposes of income tax and/or national insurance contributions. In IR35 appeals the worker is called "the worker", the service company (or other intermediary) is called "the intermediary", and the person, firm or company to whom the worker supplies work is called "the client".
WHY IS IT CALLED AN IR 35 APPEAL?
On 9 March 1999 the Inland Revenue issued a press release called "Countering avoidance in the provision of personal services". The press release was number IR35. The legislation proposed in the press release was subsequently enacted and came into force in April 2000 and has come to be known as the IR35 legislation. The legislation changed the treatment of payments made to intermediaries. The result is that, in certain circumstances, payments to an intermediary are treated as earnings of the worker in respect of employment. The changes apply to both income tax and national insurance contributions.
WHAT LEGISLATION APPLIES TO IR 35 APPEALS?
Section 60 and Schedule 12 of the Finance Act 2000 apply to IR35 income tax appeals. Section 4A of the Social Security Contributions and Benefits Act 1992 and Regulation 6 of the Social Security Contributions (Intermediaries) Regulations 2000 SI 2000 No. 727 apply to IR35 national insurance contributions appeals.
WHAT USUALLY HAS TO BE DECIDED IN AN IR 35 APPEAL?
it has to be assumed in an IR35 appeal that there is no intermediary. The question which then has to be decided is whether the worker should be regarded as an employee of the client.
IS AN IR 35 INCOME TAX APPEAL UNUSUAL?
IR35 income tax appeal is unusual because it is the intermediary which receives the decision from the Inland Revenue and so it is the intermediary which is the appellant in the appeal. However, the two persons most affected by the decision of the Inland Revenue are the worker and the client and neither of these are the appellant in the appeal.
WHAT WILL I HAVE TO SHOW?
As in almost all other appeals the burden of proof in an IR35 appeal is on the appellant. That means that it is up to the appellant to show that the Inland Revenue are wrong and that the worker should not be regarded as an employee of the client. A number of factors are relevant but none is conclusive.
Some relevant factors include:
How the payments for the work are calculated; whether this is by the volume of work done or by reference to the number of hours worked. Whether the worker gets paid for sickness and holidays and what the pension arrangements are. Whether the worker's absences have to be approved in advance. Whether the client can control what, where, when and how the work is to be done. Whether the worker must do the work personally or whether he can provide a substitute. Whether the worker provides his own tools and equipment.
Whether the worker is part and parcel of the client's organisation. Whether the worker occupies a post (such as General Manager or Secretary) in the client's organisation. Whether the worker has a job title in the client's organisation. Whether the worker works continuously for the client or whether the worker has a series of engagements. Whether the worker hires his own employees. Whether the client is obliged to offer work and whether the worker is obliged to do the work. Whether the worker works, or can work, for other clients. Whether, and under what conditions, the contract can be terminated by the client. Whether the worker assumes any financial risk. Whether the worker has an opportunity to make a profit on his own account.
WHAT DOCUMENTS WILL I NEED?
Relevant documents will include any written contract between the worker and the intermediary and any written contract between the intermediary and the client. If either of these contracts have been varied in writing then the documents about the variation will also be needed.
WHAT ORAL EVIDENCE IS LIKELY TO BE NEEDED?
Since the question to be decided is whether the worker should be regarded as an employee of the client it would be helpful for both the worker and someone from the client to give oral evidence about the factors mentioned in 6 above. Oral evidence would also be useful about: the extent to which the terms of the written contracts have been carried out: whether there has been any unwritten variation in the contracts: and whether any additional terms have been implied into the contracts.
HOW SHOULD I GET EVIDENCE FROM THE CLIENT?
You can ask someone from the client to attend at the hearing of your appeal and to give evidence on your behalf. If you wish to make sure that someone comes then you can apply in writing for a witness summons. Please read paragraph 6 of the Explanatory Memorandum which tells you how to do this.
DOES THE WITNESS EVIDENCE HAVE TO BE IN WRITING?
It is very useful for a witness to write down his evidence before the hearing of the appeal. This means that he has time to think about what he is going to say and can check any matters like dates etc. A written document containing the oral evidence of a witness is called a witness statement. It would be useful for each witness statement to cover, as far as possible, the matters mentioned in 6 and 8 above as well as any other matter which the witness wants to mention.
MUST THE DOCUMENTARY AND WITNESS EVIDENCE BE DISCLOSED IN ADVANCE?
It is a great help if copies of both the documentary evidence and the witness statements are sent in advance. Sometimes the Special Commissioners direct that this should be done. If the Inland Revenue agree with the contents of a witness statement it may not be necessary for the witness to attend the hearing. If no directions have been given in your appeal then it would help if both you and the Inland Revenue were to send copies of all the relevant documents and witness statements to the Clerk and to the other side fourteen days before the date of the hearing of the appeal.
WILL NON-EXECUTIVE DIRECTORS BE CAUGHT BY THE NEW RULES?
The "IR35" tax legislation only applies in circumstances where an individual would have been an employee of a third party if there had been a direct contract. A non-executive director is an office-holder rather than an employee. Therefore, if the individual's only relationship with the third party is as a non-executive director then the rules will not apply. Have been some suggestions that this position has been altered by the Income Tax (Earnings and Pensions) Act 2003, because Section 5 of that Act says that the provisions of the Employment Income Parts that are expressed to apply to employments apply equally to offices, unless otherwise indicated. However, Chapter 8 (the intermediaries legislation) is not expressed to apply to employments. It applies to services provided under arrangements involving an intermediary. It follows therefore that Section 5 (1) of ITEPA does not bite, with the consequence that the word "employee" in Section 49(1)(c) should not be read as applying to an office holder. Thus there has been no change as a result of the new Act.
The tax legislation may however come into play where other services, such as consultancy services, are also performed for the client through a personal service company. In those circumstances the individual might have been both an office-holder and an employee, if the relationship with the client had been direct. Whether or not the legislation would apply would of course depend on the facts. A non-executive director will be caught by the National Insurance regulations. This is because these regulations apply where an individual would have been an "employed earner" of the third party if there had been a direct contract. The term "employed earner" includes an office holder.
SERVICE COMPANY LEGISLATION (IR35) & INTERNATIONAL ISSUES
In relation to references to tax in this article, the terminology of ICTA 1988 has been used rather than that of the Income Tax (Earnings and Pensions) Act 2003.
COUNTRIES THAT HAVE A RECIPROCAL AGREEMENT WITH THE UK
Where the worker was paying social security contributions under the scheme of a country with which the UK has a Reciprocal Agreement for NICs and is sent by the client to work temporarily in the UK, under the terms of the Agreement that worker would not have been liable for UK NICs had he been an employee of the client and thus will not therefore be subject to the service company legislation.
REST OF THE WORLD COUNTRIES
If an individual was normally resident in a country which is neither an EEA country nor one with which the UK has a reciprocal agreement and services are provided to a client in the UK, then NICs may not be payable for the first 52 weeks from the date of entry into the UK. If he is still engaged in the UK after 52 weeks then liability for UK NICs under the service company legislation will arise from the 53rd week.
WILL SOMEONE WHO PROVIDES SERVICES TO A CLIENT OVERSEAS BE SUBJECT TO THE SERVICE COMPANY LEGISLATION?
If someone provides their services through an intermediary to a client overseas in such a way that the service company legislation applies, then they may have to pay tax and NICs under that legislation. For tax purposes, chargeability will depend on the residence status of the worker and the country in which the services are performed. The legislation provides for the worker to be taxed on the basis of the Schedule E treatment that would have arisen if he/she had been engaged directly by the client. For NICs purposes, the intermediaries legislation only applies where the worker would be regarded for the purposes of Parts 1 to V of the Social Security Contributions and Benefits Act 1992 as employed in employed earners employment by the client, had the arrangements taken the form of a contract between the worker and the client. However, there are exceptions to the general rule, which depend on whether the individual is providing services to a client: in an EEA country. In a country with which the UK has a reciprocal agreement. In a country in the rest of the world.
EEA COUNTRIES
Any worker employed in the territory of one EEA country is subject to the legislation of that country even if he resides in the territory of another country or the registered office or place of business is situated in the territory of another EEA country. Therefore, a worker providing services to a client in an EEA country other than the UK would be liable to pay social security contributions according to the EEA country in which he is employed and would not be an employed earner in the UK under Section 2(1) of SSCBA 1992. Consequently, the service company legislation would not apply for NICs purposes. However, there is an exception to this rule if the individual could be regarded as a short-term posted worker.
COUNTRIES THAT HAVE A RECIPROCAL AGREEMENT WITH THE UK
Under Reciprocal Agreements with certain countries outside the EEA, a worker will pay social security contributions in the country where he is working. The UK has entered into 19 such agreements. Therefore, a worker providing services to a client in a country with which the UK has a reciprocal agreement will be liable to pay social security contributions according to the country in which he is employed and he would not be an employed earner in the UK. Therefore, the service company legislation would not apply for NICs purposes.
However, within each RA a provision allows for a posted worker to remain insured in the UK for National Insurance purposes for a limited period. Each RA sets out the time limit. In this situation the individual would remain within UK NICs because he would be a posted worker, but this is because he is, as a matter of fact, an employee of his service company. It does not bring him into the scope of the service company legislation because that is based on the position which would apply if he were working directly for the overseas client without the interposition of an intermediary.
REST OF THE WORLD COUNTRIES
Any worker providing services to a client in a country in the rest of the world would be liable for contributions according to the country in which he is employed and he would not be an employed earner in the UK. Therefore, the service company legislation would not apply for NICs purposes.
WHAT ABOUT DOUBLE TAXATION AGREEMENTS (DTAS)?
The UK has entered into DTAs with most countries but the terms of these generally mean that, where a worker provides services in the UK, the UK retains its taxing rights over the deemed payment in respect of duties performed in the UK for the client. There will be a few exceptions, such as where the work done in the UK is merely incidental to the work done abroad, or where the worker is a short term business visitor (i.e. in the UK for less than 60 days in a tax year where that period does not form part of a more substantial period where the worker is present in the UK).
COMPOSITE SERVICE COMPANIES AND THE 'SERVICE COMPANY' LEGISLATION
Composite service companies exist in a number of different areas of business. These include, for example, construction, IT, teaching, medicine, accountancy etc. Composite service companies usually employ workers and then supply them to clients for whom they work. Sometimes the clients will be found via employment or recruitment agencies rather than directly via the composite service company. The employees of a typical composite service company are normally paid a small wage or salary for the work they do - usually at or slightly above the level of the national minimum wage. However, the employees are also usually shareholders of the composite service company, and each employee will usually hold a different class of shares in that company. So, for example, Employee A will hold class "A" shares, Employee B will hold class "B" shares, and so on. The employee's shareholding will then usually entitle him/her to receive dividends based on the amounts received by the composite service company for the services the employee performs for the client’s business. These dividends will supplement, often substantially, the small amount the employee is already receiving from the composite service company in wage or salary payments. Dividends may be paid on monthly or even weekly basis in some cases.
The people actually running and managing the composite service company will usually prepare all the necessary legal paperwork on behalf of the company and its employee/shareholders, including any returns to the Inland Revenue, and will charge the composite service company a weekly fee to cover administration costs. The working arrangements as described above are fairly typical arrangements for composite service companies. However, they can obviously be organised in other ways as well. Regardless of how the composite service company is organised, it will need to consider the "service company" legislation in exactly the same way that any other service company has to. The 'service company' legislation says that:
Where an individual ("the worker") personally performs services for the purposes of a business carried on by another person ("the client"). Does so via a service company rather than directly. Works for the client in such a way that they would be regarded as an employee of the client, had they worked for them directly rather than via the service company. Then the service company will have to deduct and account for tax under PAYE and Class 1 National Insurance contributions in respect of that worker on (broadly) all of the money the service company receives from the client in respect of work done for the client by that worker. This legislation applies equally whether the service company employs only one or two workers or whether, as a composite service company, it employs many workers.
In some cases, the number of employees/shareholders in a composite service company exceeds 20. This makes no difference to the applicability or otherwise of the "service company" legislation. The service company legislation will apply in any situation where the relevant conditions are met and the worker either holds 5% of the shares in the service company or receives payments which "could reasonably be taken to represent remuneration for services provided by the worker to the client".
IMPORTANT NOTE
Our corporate, tax and securities lawyers have extensive experience in the issues involved in all type of business entities, including corporations, private limited companies, public companies, limited liability companies, limited partnerships, general partnerships, limited liability partnerships and professional associations. Our lawyers advise clients in the choice of entity to utilize for any given business venture. Such advice includes the tax advantages of the respective entities as well as the non-tax or business issues involved in each type of entity.
Our lawyers continue their representation of such entities on an ongoing basis and advise the entity and its owners regarding the business issues which arise from time to time (such as labor and employment issues, tax issues, negotiating contracts, securities issues and licensing and regulatory matters). Our lawyers also represent many entities which are involved in negotiating mergers with other entities or acquisitions of other entities. This representation includes advising the business and the owners on the purchase or sale of a business and on tax-free mergers or other reorganizations of business entities, as well as structuring divisions of an existing entity into two or more new entities.
We structure a variety of commercial lending transactions including corporate loans, real estate development loans, asset based loans, agri-business loans, floor plans and home builder lines of credit. Members of our firm advise financial institution clients and their corporate counsel on a daily basis with respect to general lending issues including those relating to UK and Cyprus documentary stamp and intangible taxes, bankruptcy and creditors' rights, environmental concerns and problem loans. We have extensive experience in complex loan workouts.
The firm's Trusts and Estates attorneys specialize in estate and trust administration matters and the development of estate tax planning strategies designed to help our clients achieve maximum savings in income, estate, gift and generation skipping taxes. Our Trusts and Estates attorneys handle the traditional aspects of personal estate planning, such as the preparation of revocable trusts, wills and irrevocable trusts, and also deal with all aspects of tax controversies with the Internal Revenue Service dealing with estate, gift and generation skipping tax, including filing estate and gift tax returns, representing our clients in audits of those returns, and appeals to the IR and courts of proposed tax deficiencies.
Our attorneys monitor the latest developments in both tax and non-tax laws affecting estates and trusts and lecture extensively on those subjects around the country to numerous professional groups and organizations. The firm's Trust and Estate attorneys are proficient in analyzing and implementing the latest techniques to reduce estate and gift taxes, including, for example, family limited partnerships, GRATS and charitable remainder and lead trusts.
The firm's Trusts and Estates attorneys also advise our clients on the income, gift and estate tax consequences of charitable gifts; handle the negotiation and preparation of marital agreements; provide asset protection planning for individuals; and have extensive experience in the establishment of private and publicly supported charitable organizations, international estate planning and estate and trust litigation, as well as post-mortem tax planning. We recognize that a client's estate planning needs and matters that arise in the course of estate planning and administration frequently require expertise in other areas of the law, and we work closely with the firm's attorneys in other practice areas, including litigation, real estate, corporate and tax, to provide our clients with thorough legal advice.
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