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IR35 – Defining the contractor in legislation

Comment 8th August 2010

IR35 is a perfect example of the tax system not being able to respond to changes in the economy or changes in the way people work.

HMRC are stuck in a world where everyone is either an employee or self employed but people don't work that way any more.

There are hundreds of thousands of 'contractors' in the UK. This word is not defined in tax law currently and does not sit well with the employed or self employed duality of HMRC. IR35 was a cack-handed attempt to address this gap (and grab some extra tax by enforcing it in a bullying draconian way at the same time!).

What is a contractor?

– They are NOT employees – they do not have a salary (they invoice for their time like any other supplier), they ave no benefits (no holiday pay, no sick pay, no pension, no employee discounts etc). They find their own work on a fixed term basis and negotiate their rates directly with the client.

– They are NOT the same as Temps. Contractors tend to be knowledge workers in IT, Financial Services, HR, Retail etc.  They tend to be highly paid in terms of day rate.

– They work through their own legal entity, Ltd company or partnership. This means that they pay and collect VAT, run their own payroll, keep company accounts, take out liability insurance etc.

– Some employ others but most work on their own (what the Professional Contractors Group refers to as micro-businesses).

– They work at risk – taking responsibility for their own errors, building up reserves to cover periods where there is no work etc.

IR35 was an attempt to define what constituted employment. It is a complete failure for many reasons:

1) The rules are too vague and open to interpretation. If you pay PAYE you know how much you have to pay each month and you pay it. With IR35 HMRC can decide to investigate you at any time and apply the rules as the local inspector sees fit.

2) It fails to recognise that people do not go contracting soley to avoid tax. They do it for a number of reasons – Freedom from control, flexibility, better rates of pay and they are willing to give up all the benefits and security of being an employee to achieve that.

3) HMRC cannot see beyond employed or self employed and does not understand the contract market or the way they work.

 

What is required?

Define the contracting in statute as a new employment type and tax rules and rates that apply.

This definition should be:

An individual that engages in work on behalf of a client for a daily rate for an extendible fixed term and without receipt of any employee benefits (sick pay, holiday pay, life cover, medical benefits, pension, employee discounts, overtime, Notice period). The individual must perform the functions of a supplier and must submit invoices, have the necessary insurances in place and provide fully audit-able accounts and returns.

If this definition is met then the individual is a contractor and can remunerate themselves as allowed for the entity which they work through e.g. if a Ltd company then by salary, dividends and bonus as required. Tax will be paid in the dividends, salary and bonus as currently with the Ltd company paying corporation tax.

Dividends from contracting companies should be paid at a 40% rate instead of the 32% rate to bring it in to line with other earnings. National Insurance would not be payable but obviously the 20% corporation tax on the profits will make up the majority of that difference. Dividends should be able to be split between husband and wife as recently up held at the court of appeal (The Arctic systems case).

 

 

 

 

Why does this matter?

A flexible labour force will be critical to the UK economy over the coming years. More people want the flexibility to be able to contract and so it is essential that this way of working is recognised and defines clearly.

A HMRC investigation is incredibly stressful for the one being investigated when the rules are so unclear. In addition it is costly to both parties (I dread to think what the Arctic Systems case cost the taxpayer).

Contractors work at risk and aid some of our biggest companies at times when workload exceeds available resource. Contractors deserve stability and certainty and to be able to enjoy the fruits of their labour.

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