One of the problems which can arise with you personally also being a party to the contact is the risk of the taxman insisting on tax being deducted under PAYE/Schedule E from payments due to you or your company.
Section 134 of the Income & Corporation Taxes Act 1988 expressly requires Schedule E (ie PAYE) tax to be deducted by an agency, where a worker is:
Social Security (Categorisation of Earners) Regulations 1978 has similar implications re Class 1 National Insurance.
This is the fundamental reason why contractors in the computer industry work through limited companies, and for the contractor also personally to be a party to the contract risks undermining the 'work-around'. It’s probably true to say that perceived abuse of this use of limited companies was a major reason for the introduction of IR35.
Note that the section imposes the requirement to deduct tax where the contract is between 'worker' and 'agency'. It is my view that the requirement of the section may well also apply where the contract is three-way ie between worker, his company, and the agency.
If the Revenue were to actually look at the contract, it might be that they could well take a strict interpretation of this requirement. We have not heard of any such cases – but that’s not to say that it couldn’t happen.
There are dangers here both for the contractor (who can suddenly find himself receiving a payment in net terms rather than gross), and even more so for the agency, who could suddenly be faced with an absolutely crippling bill for all the tax and NI that they should have deducted in the past in respect of every contractor who has ever worked for them - so large that it could ruin even the largest of agencies.
The only safe way to avoid this risk to both parties is to ensure that the contractor himself is not a party to that contract.
Position of an LLP:
Unlike a conventional partnership, an LLP (Limited Liability Partnership) is an independent legal entity in its own right. Therefore an individual partner in an LLP is not a party to a contract between an LLP and an agency. From that it follows that a contract between an agency and an LLP cannot fall within s134 / s44+.
I'd really appreciate your feedback on this FAQ - so mail me and tell me what you think of it, if it's been useful to you, or let me know of any specific problem you have where I may be able to help.
This page was last updated 27th March 2004.
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