IR35 is the United Kingdom anti avoidance tax legislation designed to tax "disguised employment" at a rate similar to employment. In this context, "disguised employees" means workers who receive payments from a client via an intermediary, for example, their own limited company and whose relationship with their client is such that had they been paid directly they would be employees of the client.
Before IR35 was introduced workers who owned their own companies were allowed to receive payments from clients direct to the company and to use the company revenue as would any small company. Company profits could be distributed as dividends, which are not subject to National Insurance payments. Workers could also save tax by splitting ownership of the company with family members in order to place income in lower tax bands. (This latter practice was recommended by government publications advising on setting up family businesses, but attacked as tax fraud by other government departments, notably the Treasury. It came under separate, ultimately unsuccessful attack in 2007, see S660A.)
On 20 May 2010 the new Liberal Democrat/Conservative coalition Government's Programme for Government announced a commitment to "review IR 35, as part of a wholesale review of all small business taxation, and seek to replace it with simpler measures that prevent tax avoidance but do not place undue administrative burdens or uncertainty on the self-employed, or restrict labour market flexibility." On 10 March 2011 the Office of Tax Simplification recommended that the Treasury should suspend IR35 or compel HM Revenue & Customs to make changes to its implementation until wider structural reform to integrate Income Tax and NIC is introduced. After that, the Chancellor announced the Government would keep IR35 'as is' during Budget 2011, but with changes to HMRC administration and to create a new IR35 Forum.
Background and contents
In 1999, as part of that year’s Budget, the UK’s Chancellor of the Exchequer, Gordon Brown, announced that measures would be introduced to counter tax avoidance by the use of so-called personal service companies. Properly known as the "intermediaries legislation", it is more commonly referred to by the consecutively numbered Inland Revenue (now HMRC) budget press release number 35 in which it was announced (i.e. the 35th press release of that year), titled IR35: Countering Avoidance in the Provision of Personal Services. The press release was issued on 9 March 1999, the same day as the Chancellor of the Exchequer's budget statement.
It came into force throughout the UK in April 2000. Although it was part of that year's Finance Act and was not law at the start of the Financial Year, the Act backdated its commencement to 6 April 2000. The legislation has been consolidated in the Income Tax (Earnings and Pensions) Act 2003 and in the Statutory Instrument Social Security Contributions (Intermediaries) Regulations 2000, SI 2000/727.
Historically, it had been advantageous for the owners of a small company to take all of their wages in one month, thereby only incurring NI contributions once (up to the monthly ceiling) instead of paying a regular contribution every month like most employees. This ploy had been circumvented some years prior to the introduction of IR35 by imposing NI on the total annual income of directors as if it were spread over the year, even if only paid by one payment. The increased usage of dividend payments instead of wages was partly a reaction to this change. An additional sense of grievance felt by those who were driven to incorporate, for whatever reason, was the large disparity between the National Insurance burden on companies and employees (>20% if the employer's contribution is included) and that imposed on the self-employed.
The stated aim of the measure was to prevent workers from setting up limited companies via which they would work effectively as employees, but saving on tax. The so-called "Friday to Monday" scenario, that it was possible for a worker to leave a job on Friday and return on Monday to be doing the same work for the same company, but, as a contractor via their own limited company paying a lot less tax, was cited in the press release as the anomaly being corrected. In such a scenario, HM Revenue and Customs would be allowed to "look through" the contractual arrangement between the worker’s company and the client company and to formulate a "hypothetical contract" which showed that the worker was a "disguised employee". The fee paid to the worker’s company would then be taxed as a salary. Normal employment status rules should be applied when considering IR35 status and the view of HM Revenue and Customs can be successfully challenged.
- There are clearly cases of "Friday to Monday" — leaving on Friday as an employee and returning on Monday to the same job as a hired consultant — which are obviously tax dodges.
- That it is unfair that two workers performing the same tasks should be taxed differently, when there is no real difference between their circumstances.
- That the lower taxation applied to large companies should not be available to small companies, which are in reality one person as income earner (and perhaps a wife/husband handling the paperwork).
Some of the key criticisms levelled at the measure include:
- IR35 does not achieve its stated aim of taxing those within IR35 at the same level as employees since those within IR35 also pay Employers NI in addition to Employees NI. This results in much higher levels of tax being paid by those within IR35.
- Its complexity and its harmful impact on many small companies which exist for reasons other than tax avoidance or evasion. These include many companies owned by IT professionals, who often have many short-term contracts rather than one steady employment.
- That its effects extend far beyond the Friday to Monday scenario envisaged in the original press release, which indeed has never been discussed much since.
- That it is unclear whether IR35 applies to an individual contract or not, and the Revenue will not give an opinion until the contract has been signed. As their ruling can imply significant extra taxation, this means that payment negotiations have to be made in ignorance of the taxation costs involved.
- That it is unjust that workers in small family businesses should be taxed as if they were employed by their clients, yet not receive any of the legal, state and other benefits received by "normal" employees.
- There is little evidence that it raises any significant amount of money.
- It renders small businesses uncompetitive with large consultancies and encourages off-shoring.
- The calculation of a "deemed payment" under the legislation is very complex, if you consider yourself caught. The calculation involves 11 separate stages, some of which are recursively dependent on others.
- The introduction of IR35 combined with its complexity and ambiguity, led many freelancers into a number of Tax Planning schemes that led to a further loss of revenue to HMRC.
It is hard to judge the effectiveness of the legislation, since as of 2010 the UK Inland Revenue have not published any figures. On 6 Jan 2004 Dawn Primarolo was asked in Parliament how many investigations under the IR35 regulation have (a) been initiated, (b) resulted in additional revenue and (c) been concluded without securing additional revenue. In a written answer she replied that it was not possible with any accuracy to isolate data relating solely to this legislation.
On 15 June 2009 in the House of Commons Labour MP Terry Rooney (Bradford North) asked the Chancellor of the Exchequer "how many investigations concerning IR35 were launched in each of the last five years; and how many of them resulted in (a) prosecution, (b) an increase in tax due and (c) no further action". Kitty Ussher speaking for the Chancellor replied, "The intermediaries legislation, commonly known as 'IR35', was introduced with effect from 6 April 2000 to counter the avoidance of employed levels of tax and national insurance by individuals providing their services through intermediaries. Disclosure of HM Revenue and Customs' compliance data relating to the legislation would result in a risk of non-compliance with the legislation. Accordingly I am not able to provide the data requested." The July 2009 issue of IT Now, the British Computer Society magazine, reported that between April 2002 and March 2008 the Government had raised £9.2 million under IR35 legislation compared to the £220 million that it was initially expected.
The initial regulatory impact assessment for IR35 in 1999 stated that HMRC expected the measure to generate £220 million per year in National Insurance contributions, and a further £80 million in income tax.
On 6 Jan 2004 Dawn Primarolo was asked by the Shadow Paymaster General Mark Prisk MP about additional revenue secured from investigations under IR35. She replied that "Establishing whether or not the intermediaries legislation applies is undertaken as part of the Inland Revenue's Employer Compliance Review programme. As such it is not possible with any accuracy to isolate data relating solely to this legislation." She gave a similar answer when asked about administration and employment costs.
In May 2009 the Professional Contractors Group received a reply to a request under the Freedom of Information Act to HMRC, asking just how much tax revenue IR35 had in fact raised for the exchequer. The FOI reply revealed that in the tax years 2002/03 to 2007/08, IR35 directly raised just £9.2 million. This equates to an average of around only £1.5 million per tax year, less than 1% of the expected amount. It is not clear whether this includes the NI contribution, or is just income tax.
In September 2011 a Freedom of Information Request revealed that the number of cases reviewed had fallen from 158 (year ending April 2007) to 12 in year ending April 2010 and 23 in year ending April 2011. The same document also gives the "tax yield received for the requested years" as having fallen from £1,906,619 to £219,180. No details are given for the costs of the investigations or the costs of collecting the tax. It is not clear whether this figure relates to the revenue raised from investigations, or the total revenue from IR35. No figures were given for the cost of administrating the tax, or the cost of the investigations.
- Umbrella company
- UK labour law
- UK tax law
- Independent contractor
- Misclassification of employees as independent contractors
- "The Coalition: our programme for government" (PDF). HM Government. May 2010. Retrieved 2010-05-20.
- "IR35: Countering Avoidance in the Provision of Personal Services - Judgment of court case CO/2302/00". HM Revenue and Customs. 2 April 2001. Retrieved 2010-07-13.
- "IR35: Press Release dated 9 March 1999". HM Revenue and Customs. Retrieved 2010-07-13.
- Press Release dated 23 September 1999 by the Chancellor
- Press Release 14/00 from HMRC
- "6 Jan 2004: Column 224W". Hansard. 6 Jan 2004.
- Hansard 15 June 2009 : Column 53W
- IT Now - Vol 51, Part 4 - British Computer Society, Swindon - ISSN 1746-5702 - July 2009
- "The Welfare Reform and Pensions Bill Regulatory Impact Statement - National Insurance: Service Provision Through Intermediaries" (PDF). Inland Revenue. October 1999. Retrieved 2010-07-13. National Insurance figure is at the top of page 5, overall revenue is in paragraph numbered 41 on page 12, from which the tax figure of £80 million has been derived by subtracting £220 million National Insurance
- The Register
- HMRC website