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The worst fears from the introduction of IR35 were never realised but, nevertheless, the effect of its application to individual cases have been and may still be significant. HMRC do not now appear to be putting much resource into this and, we suspect, with the narrowing of the differentials between corporation and income tax/class 4 national insurance by April 2009 will make IR35 of very limited application in future.
The problem
as was
Many contractors who used their companies to achieve significant national insurance savings by using a policy of:
- Low remuneration and high dividends; and,
- Having spouse or family shareholders to shelter dividends from higher rates of tax
will be uncertain whether they can continue to enjoy this benefit from 6 April 2000 by reason of IR35.
Put simply, where the status of an individual vis-à-vis the ultimate business recipient of his/her services would be held to be an employment relationship then the existence of the intermediary (i.e. the contractor's personal service company) is effectively disregarded for tax and national insurance purposes. In other words, a contractor who uses a personal service company will, from 6 April 2000, will pay a similar amount of tax and national insurance as if directly employed.
Schemes to avoid IR35
A number of schemes have been put together to try to avoid the application of IR35. In our view, schemes which artificially obscure the status of the contractor would not withstand a concerted challenge by HMRC. The more important question is to what extent the Revenue will devote the resources to mount a concerted challenge!
Avoidance of IR35
In our view, anyone wishing to conclusively avoid the consequences of IR35 must become a genuine entrepreneur. That means being prepared to take ordinary business risks and be subject to ordinary business pressures, the most important of which are:
- Performing fixed price work (i.e. no absolute assurance that adequate income will be made from the assignment)
- Conducting more than one contract in hand at any one time
- Having an employee who can assist you and in certain circumstances substitute for you
In addition, other matters which not necessarily individually persuasive may tip the scales against the application of IR35. For example having:
Public liability and/or professional indemnity insurance
Flexibility in the way the assignment is conducted.
Taking the risk?
Ignoring IR35 and taking the risk that your company will not be picked up is very dangerous because HMRC have the power to go back six years. You may therefore continue for several years without apparent difficulty. But when the assessments are rolled up with the interest and penalties the effect would be horrendous.
Neither should one ignore the possibility that if the company became insolvent and failed by reason of the assessment, HMRC could have recourse against the directors via:
i) The Insolvency Act 1986 where the directors could be held to have failed in their fiduciary duties to its creditors to keep its property inviolate and available for the repayment of its debts. If the directors have been negligent in recording their company's liabilities which, had they had done so, the company would have been insolvent, then the directors are at risk of personal liability for the debts by reason of wrongful trading.
ii) The regulations under the Income Tax (Earnings and Pensions) Act 2003 which may be invoked where "it appears to the Inspector" that there may be tax payable under PAYE that had not been paid to the collector and had not been recorded on an end of year return [P35]. In such circumstances, the Inspector may determine the amount of that tax to the best of his judgment. Where the employer fails to pay the determination, HMRC have powers under the Regulations to recover the tax from the employee.
In other words, a contractor can be made personally bankrupt for the failure of his company to apply IR35.
Difficulty in avoiding IR35 for certain industries
Because of security regulations, contractors working in the nuclear and aerospace industries, where multiple contracts and substitution are not possible, will have a particular difficulty with IR35.
If IR35 cannot be avoided:
Continue or PAYE? Not withstanding that IR35 might apply to a particular personal service company, care should be exercised before accepting PAYE employment and closing the company. It may still be of net benefit to you to keep your company even though IR35 applies, for example:
- A total of 5% of income is allowed to cover the company's administrative expenses over and above any expenditure that would normally be allowed on a PAYE basis. This sum would normally comfortably cover the additional costs of maintaining a company and therefore could represent a net benefit compared with direct employment
- For any company that has made substantial contributions into an executive pension scheme, a serious over-funding problem may exist if the company ceases to continue. Good financial advice is essential. It may be beneficial to continue with your company at the higher earning level dictated by IR35 to correct an over-funding position.
Advisory service
We offer an advisory service whether an individual's circumstances fall within IR35 and to recommend an appropriate course of action to facilitate exemption. The following services are available as a standard package if you wish to continue to use your company:
Main service
- Advice on maintenance of director's loan (current) account and related tax consequences
- Calculation of director's remuneration
- Calculation of dividends
- Quarterly VAT return
- Preparation of annual financial accounts
- Preparation of corporation tax computations and CT600 corporation tax return
- Organising completion of annual return and other filings with the Registrar of Companies
- Making elective resolutions and preparation of minutes of statutory meetings of the company
- Being registered office for the company
- Assistance in all PAYE and NI matters
- Preparation and filing of forms P11D
- Meeting to discuss accounts and review financial position
- Dealing with routine tax enquiries
Ancillary services
- Preparation of directors' personal tax returns
- Preparation of "spouse's" return
- Liaising with director's financial service providers
Typical accountancy fee for this service is £800 p.a. + VAT.
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