IR35 defence strategies – keeping the Inland Revenue off your back

David Smith is the founding director of Accountax, a specialist accountancy firm, and author of Tolleys IR35 Defence Strategies, From Contractors to Commisioners - a book that seeks to explain a multitude of IR35 defence strategies for contractors and the self-employed. He has a great deal of experience in the area of IR35, having fought more than 470 cases on the matter over the past few years, so we spoke to him about the regulations to find out what all the fuss is about.

Could you firstly tell us the basic premise of IR35?
Certainly. IR35, which got its name from the Inland Revenue press release announcing it - which was number 35 - basically says that: If you are really an employee of your client then you should be taxed and you can't get around that by saying that you are self-employed or by contracting yourself through your own limited company.

Okay, can you now tell us a little about contractors and where they fit into the IR35 equation?
A lot of the contractors that you come across nowadays are people who were made redundant in the late eighties and early nineties and couldn't find work. Instead of sitting around they got up, formed their own limited companies, trained themselves up on all the latest technologies and set themselves up with a nice little business doing contracts for other organisations - things like project management, programming etc. Then IR35 came around and, to many of the contractors, it looked like a personal assault. Senior Government figures were talking about IR35 in the same breath as tax cheats and it all become very emotive. To the contractors that had just spent the past ten years building a solid foundation, with the backing of the Government and its support for the entrepreneur, it looked like a personal assault.

We recall stories in the press talking about IR35 trying to catch the tax cheats, is that why it was brought in?
No not at all. The IR35 regulations were first thought of in the eighties but were dropped because they were just too complex. When they came back around they were implemented simply because the Government wanted to generate more tax revenues - and that's not a political statement at all - that's a fact. IR35 is all about increasing revenues, it's not a personal assault on tech workers or anything like that, it's a plain and simple numbers game.

But surely people were abusing the system previously?
I imagine some people were abusing the system - and I have no sympathy for them. But the majority were doing everything within the law. You hear nowadays of people talking about contractors saying that they were taking money out of their own limited companies in the form of dividends rather than a pay packet. And some people think that this was abuse of the system. But there was absolutely nothing wrong with doing that, the law said you could do that so people did it and that is not abuse of the system at all. I think people forget that these contractors and small businesses did an awful lot for the UK; they were spending a lot of money on training and technologies and they were keeping many businesses up to date through their own investments.

Okay, so now IR35 just makes sure that you are self- employed. That seems pretty clear cut

Actually it isn't and this is the big problem. There is nowhere in law that actually defines self-employed. Nowhere at all. Therefore, what has happened over the years is that self-employment has been defined by case laws that have narrowed the definition. These cases haven't just been about people working as an employee and claiming they were self employed for tax reasons, these cases have included everything from injuries at work, to unfair dismissal, so nowadays it's pretty clear what constitutes being employed or self employed - if you know where to look.

So how do you know if you are self-employed?
There are basically three defining factors that allow you to assess whether or not you are self employed. The easiest way to do it in fact is to figure out if you are an employee and you can do that by considering the following three points:

Firstly, to be a recognised employee by law, you have to be sufficiently controlled by your employer so that you have what they would call a master/servant relationship. In other words they control what you do. Your employer is your master.

Secondly, you must be required by your employer to give a 'personal' service. By this I mean could you, for instance, send someone else in to do your job or does it say that you have to do the work? If you could send someone else in to do the job then you are not an employee.

Thirdly, we have what's called a Mutuality of Obligations. As an employee you have to have the offer of ongoing work and you have to accept it. So, for instance, my secretary will leave the office on Friday afternoon knowing that she is coming back in on Monday to her job - so she has a mutuality of obligations. With contractors, they might do a week or a month and then the job ends. At the end of that they might be asked to come in to do some more work but they don't have to accept and the workplace doesn't have to offer.

If you don't have all three of these in your current workplace then you are not an employee - that's the law.

That seems pretty clear too, how come there are so many disputes?
The reason for the dispute is that people, even people earning an awful lot of money, may not actually have a contract that spells out the terms of their engagement with the company. And if you are a contractor without such a contract the Inland Revenue (IR) will come down on you as hard as it possibly can and start applying its own interpretations of your situation. It will fight the case that you are actually an employee and it will attempt to recover lost revenues. The IR knows that it's usually arguing against accountants who have little experience of these matters and that it has a good chance of winning the case. And it's at times like this that it can get pretty hairy.

Does that mean the contract under which you are employed, or your company is employed, is absolutely critical?
Most certainly, yes. The contract is really the single defining issue on these matters but, as I said, very few people actually have a contract the explicitly spells out the relevant clauses and standards and that's when the IR will come after you.

So who would be liable in this situation?
The contractor's limited company, not the employer, would be liable for the lost tax payments. That's who the IR would chase. In this situation, many contractors say that they would close the business and open a new one, but actually IR can come for the director of the company themselves so it's not easy to avoid.

If this is really about contracts then isn't it about time businesses woke up to that and started ensuring contractors are getting the right contracts?
There is certainly an element of that, yes. The problem is that the employer often doesn't care. They don't face any costs so they just shrug their shoulders. To be honest this gets even worse the bigger the company that you encounter. The larger companies take the view that they have had employment contracts drafted by very expensive lawyers and they aren't prepared to change them for a few contractors. Having said that though, we just did a contract for Texaco. It approached us and said it wanted a contract that would ensure it's contractors weren't a point for dispute so if they can do it there's no reason why anyone can't.

Is it just the case that employers haven't caught up with the legislation yet?
It's not just that. There are people out there who try to hide their full employment underneath a limited company. One guy who had been at HP recently took it to court because he claimed he had been unfairly dismissed. But he was a contractor. On the one hand he wanted the tax breaks and benefits associated with being self employed but as soon as the contract dissapeared he wanted employee's rights. Suffice to say he lost the case. But there is still quite a bit of this going on. We have fought a lot of tribunals on this kind of thing.

David, IR35 seems to be a lot of fuss about very little. Are we missing something?
Yes I think you are. In essence, perhaps, IR35 isn't a big deal but I say that as someone that has come from a legal background, that has spent years at the Inland Revenue and now has a specialist business looking at this. For the average man on the street IR35 can be, and often is, a very complex arena indeed. The key to it all, though, is making sure your contract is right. If you have that then IR35 does not apply, it's that simple.

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