March 7, 2012

Ask the expert: IR35 income tax liability

Q: How do I structure my agreements so as to best protect my sub-contractors from IR35 income tax liability?

A: IR35 is a notoriously problematic area of law introduced in April 2000. It is designed to restrict individuals seeking to avoid paying income tax and National Insurance Contributions by supplying their services through an intermediary body (often a personal service company) and paying themselves in dividends rather than salary. IR35 legislation gives HMRC the ability to look beyond the wording of the contract in order to determine how the worker should be taxed.

In a sub-contractor arrangement, there will generally be two contracts:

  • Between the sub-contractor and the client
  • Between the sub-contractor and the worker

It is the contract between the sub-contractor and the client that is most likely to be the focus of HMRC attention. There are two key aspects to reducing the risk of IR35 applying to your arrangement; the way in which your agreements are drafted and the way in which you operate in practice.

Agreement between you and your sub-contractor:

  • State in the agreement that it is not envisaged for the relationship to be one of employment. Whilst HMRC will look behind any labels it is helpful to show the intention of the parties.
  • If possible, include a right of substitution.
  • Avoid an obligation to provide and accept work.
  • Relate agreement to a specific project rather than a period of time. Ideally payment should relate to completion of the project (or an element of it) rather than time worked.

The way in which you operate:

  • Require the sub-contractor to provide his own equipment. For example, resist the urge to offer a company laptop.
  • Exercise as little control as is practical. For example, ensure that you don’t require the sub-contractor to start and finish at regular times, allow him to set his own hours of work.
  • Ensure that the sub-contractor is not integrated into your company more than necessary.

It is essential to seek legal advice on both your agreements and the way in which you operate if you are to successfully protect your sub-contractors.

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