Wednesday, 16 May 2012

Update on Intermediaries Legislation (IR35) and business entity tests

On 9 May 2012, HM Revenue & Customs (HMRC) issued updated guidance on IR35 matters ( This is HMRC’s first significant IR35 update for several years, and sets out a new process, to help a limited company contractor in deciding whether it is at risk of being caught by the intermediaries or ‘IR35’ legislation.

The basic IR35 test, of whether an engagement would correctly be regarded as employment or self-employment but for the use of the contractor’s limited company, has not changed. However, the new guidance introduces the concept of ‘business entity’ tests, in effect using a points scoring methodology to help indicate whether a contractor is in business on its own account and hence outside IR35.

What do I need to do next?

Whilst it is important for contractors to read the announcement and take it seriously, we would avoid any immediate ‘knee-jerk’ reaction. For instance:
  • The new business entity tests are intended as a methodology by which the contractor may seek to establish whether they are at high, medium, or low risk of review by HMRC. However HMRC has indicated that use of this methodology is not compulsory, and there is nothing to suggest that any particular contractor will be reviewed immediately. Whilst HMRC has said that it may seek to establish the level of risk for an ‘IR35 review’ on the basis of these tests, official HMRC statistics suggest that IR35 investigations have historically been on the decrease rather than increase. Although there is no certainty this trend will continue, Primat is not currently aware that any of its contractors is currently the subject of such an investigation. 
  • The guidelines contain tests and scenarios which are being piloted, and as HMRC has confirmed they will need time to bed in, there may be updates and changes which need to be fully considered.
  • The tests and associated evidence required are not directly based on case law and, in themselves, have no standing in law. The question of whether an engagement would correctly be regarded as employment or self-employment is a test of employment law, and (in the event of ongoing dispute) this would continue to be determined by independent courts and tribunals. Remember, the new guidance is not a comprehensive guide to IR35, nor does it provide a definition of employment status; it is simply a guide to advise which level of risk band for HMRC review a contractor falls within. NOTE: the guidance does not confirm whether or not IR35 applies.    
  • In Primat’s view the points scoring system does not give the correct weight to certain aspects, based on current case law. For instance we would not agree that a ‘right’ to provide a substitute bears only 10% of the weight that actual use of a substitute bears (indeed one of the example scenarios, “Hamish”, cites the right alone as a clinching argument that IR35 does not apply). Also, one of the primary tests for any court or tribunal would the evidence of ‘mutuality of obligation’ (the ongoing obligation for one party to provide work and the other party to perform it), and this has largely been ignored in the HMRC guidance.

What is Primat doing to help its contractors?

As mentioned, it would be inappropriate to make or propose significant changes (e.g. to any contractual terms) at this early stage, and especially while the new guidance is in its infancy and may change or be updated. However, Primat recognises the concern and uncertainty which these matters may cause to contractors. Therefore we are proceeding with a number of practical initiatives in the meantime, including:
  • We are working with our clients to ensure they are aware of the new guidance. As well as feeding back any direct contractor concerns, where possible we will ask clients to support the contractor’s position. For instance, in cases where it may historically been difficult to demonstrate substitution (including the basic right and practicalities), we are seeking to establish initiatives with our clients which may help this process.
  • We can also offer assurance and support to our contractors that, in the event a limited company contractor becomes the subject of an IR35 review in relation to a Primat engagement, we will work in conjunction with you and your advisers to provide all the relevant information to confirm the nature and intention of the contractual engagement.  It is our view that Primat’s standard engagement contracts are outside of IR35 and we offer our assurances that we will do everything reasonable and within our powers to support the contractor in any such matter. We enjoy an excellent, albeit arms length, and proactive relationship with HMRC, and the Revenue authorities have recently reviewed and accepted our standard contractual arrangements. Our professional advisers also have extensive experience in these matters, and together we intend to keep abreast of current HMRC thinking and its practical implications.
Should you require bespoke tax advice, please of course consult your own professional adviser. However in the event you feel we can assist you further, e.g. to consider these principles generally or to discuss the initiatives that Primat is undertaking with its contractors and clients, please do not hesitate to contact your designated consultant.


Unknown said...

But was it really an update? At least the new points system helps to give us freelancers an insight into how the HMRC values our accounts, although the points system seems to favour certain contractors more than other. I'm sure it could be abused a little too.

My only real question is whether people with lots of points will be overlooked entirely or just far less likely to be investigated based on the ir35 info I have so far?

Unknown said...

Hi Adam

Thanks for your comments.

It’s a valid point that it does give some indication into HMRC’s values for identifying cases which may be at risk of falling within the IR35 rules.

In answer to your question; At this point, business entity testing has been issued by HMRC as guidance to enable contractors to self-audit and determine the extent of the IR35 risk for themselves, not as a mandatory obligation for the limited company to then submit to HMRC.

This essentially means that HMRC ‘investigators’ should not get sight of a limited company’s self-audit scoring and therefore their ability to assess a limited company for review on this basis would not exist.

Unless the HMRC make business entity testing a mandatory annual submission, it cannot be used by the HRMC to target companies for investigation. It should be assumed though that if HMRC undertakes it own business entity test on a company, and this is a low score, it is likely to investigate further to determine whether it falls within IR35 for the contract being assessed. Conversely, if the score is high, it would appear that it is very unlikely that such a further review would be undertaken. Remember though that these proposals need to be tested in practice and no doubt we will see some changes to how HMRC will approach the overall procedures when these have bedded in.

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