There’s no substitute for IR35

Introduced as far back as April 2000, the rules on the taxation of ‘personal service companies’ – commonly known as IR35 – have been the source of much comment, much argument and indeed much time in court ever since.

Setting out to negate the tax advantages for employees leaving their jobs and ‘returning to work the following Monday’ under the wrapper of a personal service company, IR35 essentially forces the company to operate PAYE on monies it would otherwise be able to pay out to the owner in the more tax-efficient form of dividends (dividends do not suffer NICs – wages mean liabilities of up to 12.8% for the company and 11% for the owner).

It does this by posing a hypothetical question: if you ignore the existence of the personal service company, would the arrangement between the ‘worker’ and the end-user be that of employer/employee or self-employed contractor/client?

If the latter, then there is no problem – IR35 does not apply – and this is why most small limited companies continue to operate without falling foul of IR35. However, in cases where the hypothetical arrangement would result in the worker being categorised as an employee, IR35 applies and the company is liable to calculate and make PAYE payments.

The recent case of Dragonfly Consulting highlights the importance of applying the ‘spirit’ as much as, if not more than, the letter of the law. In that case, Mr Bessell provided his services through his company (Dragonfly) and an agency to the AA. Mr Bessell worked as a key-member of a team in the AA, but his advisers relied on a substitution clause in the contracts to evidence the claim that if you asked the hypothetical question, Mr Bessell would have been categorised as self-employed. But the fact of the matter was that any substitution would have been subject to obtaining the agreement of the agency and, it is felt, would probably have been rejected by the AA. Consequently, the court found against Mr Bessell and Dragonfly and IR35 applied.

Two things come from this. First, IR35 is very much a live issue. HM Revenue & Customs is looking very closely at cases where the personal service company rules might apply – understandable, given that 23.8% might be at stake. And second, you cannot rely on the words in a contract if the reality is something different – the courts can and will look at how things really work before delivering their verdict.

Please contact us if you have any questions or concerns about IR35.