The ongoing saga of IR35 continues to dominate my mail; so let's just review where the issue stands at present.
The government plans to change the way in which Contractors pay tax and National Insurance on contract income; whilst Contractor's companies will continue to be paid gross (ie without deduction of tax and NI), their freedoms to manage their own affairs will be substantially reduced; the comparative freedom they now enjoy to set against tax a wide range of business-related expenses will be replaced by a flat rate allowance of 5% only against turnover, and so the opportunity to invest income in the future development of the business, without that income first suffering tax and NI at the highest rates, will go.
At the end of a tax year, substantially all income from relevant contracts will, subject to this flat rate 5% allowance, be treated for tax and NI purposes as though it had all been income of the individual Contractor from employment; Contractors can of course continue to employ administrative staff, or invest in future development - but they will have to do so out of income which has already suffered tax and NI at the highest rates, and will lose the opportunity to reduce the burden of tax and NI by taking dividends in the way the owner of every other business is able to, or to share dividend income with others.
The proposals, intended to come into force in April 2000, were first put forward in March 99, and revised in September; a decision will have to be made on a contract-by-contract basis by the Contractor as to whether or not earnings from that contract fall within the new rules, and it will be the responsibility of the Contractor to see that his/her company assesses and pays tax accordingly - an expensive mistake for those who get it wrong!
To understand more recent developments, we need to look at the way the laws governing tax and NI are structured; taxes are governed by one set of parliamentary Acts, whilst NI is governed by another set of Acts, and also by regulations. The framework, once laid down, is administered by the Inland Revenue, who develop their own guidelines.
To achieve their desired end result the government had to first change the Acts governing NI; these changes would then permit new NI regulations. These changes were introduced in the Welfare Reforms and Pensions Bill. There was a hiccup here because the House of Lords in October rejected these proposals. However, the same changes were reintroduced in the Commons, and came back to the Lords on 8th November, when they were again debated - in the course of which Lord McIntosh on behalf of the government said, of representations made by the Professional Contractors Group (see http://www.ir35update.co.uk), 'I have never encountered such a literate, persuasive group of letters…they are literate, well spelt (!), well argued, persuasive letters - and wrong.' (The reader's opinion may of course differ from mine, but I have to say I find the sheer arrogance of that comment breathtaking.) The end result of that debate was that, in keeping with parliamentary convention, the Lords did not reject the proposals a second time, and so the framework for the NI changes has now passed into law.
As matters stand at present therefore, we must treat the new proposals as happening with effect from April', although we have yet to see the tax legislation and the NI regulations.
Whether or not the new rules will apply to any given contract will depend on the (in my view) wholly artificial test of whether or not the arrangements under which the Contractor works would have amounted to employment of the Contractor by the Client, if one disregards the fact that the contractual arrangements are in fact with the Contractor's company and not the individual Contractor. This question Is to be answered according to long-existing legal rules which define the nature of the employment relationship.
The way in which the Revenue view these rules has now been set out in guidance they have published at http://www.inlandrevenue.gov.uk/ir35/draftgn.htm. My own Freelance Informer article of 29th October anticipated these requirements in a list of 11 points, to which I will now add but one more - the question of the extent to which the Contractor is 'part and parcel' of the Client's organisation - other things being equal, a contract under which a Contractor who is engaged to manage a Client's own staff is more likely to be treated as an Employment-Type Contract than one under which a Contractor is providing something more akin to straightforward consultancy.
What is becoming clear to me is that there will be many Contractor-Agency and Contractor-Client relationships which are capable of being structured so as to be outside the new rules. However, the problem then shifts to motivating the third parties dealing with Contractors to accept - from a commercial point of view - that it may also be in their interests to structure their arrangements with Contractors in different ways. There is no 'quick fix', however, and no universal way to achieve this which is easy to apply across the board. Sadly, I am already finding myself advising Contractors that contracts put in front of them by Clients and Agencies, if accepted, would clearly fall within the new rules - even though with a little thought and understanding by all concerned of the issues, the contracts could easily be changed so as be outside them.
26th November 1999
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.
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