Insurance companies which provide cover to businesses against the costs of HM Revenue & Customs enquiries are reporting an increase in the number of “IR35” cases being taken up for review. The IR35 rules are so called after the press release announcing their introduction and can apply where freelance workers trade through an intermediary, usually a limited company. What normally happens is that the freelancer channels his fees through the company and, after deducting his business expenses, uses the remaining profits to pay himself dividends rather than salary. The main benefits of this are that tax relief is obtained on the majority of expenses and the payment of dividends does not attract national insurance contributions. Compare this with the position of an employee, who can only claim a very limited range of expenses whilst being paid a salary on which NICs are due, and it is easy to see why HMRC don’t like this arrangement. The IR35 rules are designed to create a statutory fiction which is intended to allow HMRC to treat the fees paid by the client to the intermediary company as earnings of the freelancer on which NICs (including employer’s NICs) are due. They also make it extremely difficult to claim tax relief on most business expenses, irrespective of whether or not these were validly incurred.
Unfortunately, the rules have been drafted in response to a perceived abuse of the tax system which does not necessarily exist in reality. Not only are they widely regarded as unfair in principle, they are often extremely difficult for HMRC to enforce in practice. An organization called the Professional Contractors Group (now just PCG) was set up in 1999 specifically to oppose its implementation and since then has represented its members in 1,494 cases, of which HMRC have won just 8. This, coupled with the consequent low revenue yield, has led to considerable criticism and the new Office for Tax Simplification is currently conducting a wide-ranging review of the taxation of small businesses, including IR35. However, even if the rules are to be repealed, and it is by no means certain that they are, it would certainly be foolish to disregard them in the interim, particularly with HMRC apparently on the warpath.
What is essential in any IR35 case is to determine whether or not a freelance worker, working for a client through an intermediary, would be treated as an employee of that client were it not for the insertion of the intermediary in the contractual arrangements between the parties. This requires a thorough review of the contracts to determine the circumstances of each particular case and, in the absence of any statutory definitions of employment, the application of a considerable body of case law. This is a notoriously grey area of taxation and has created considerable uncertainty for many small businesses and professional advice should be sought if there is thought to be any exposure to HMRC attack. The IR35 rules are draconian in nature and make very little allowance for commercial reality and their potential impact on a business is not to be underestimated. Please call your contact partner if you have any concerns with these issues.