3. I've got my first contact, now what about IR35?

The IR35 legislation is designed to increase the NIC revenue from the service industry, which on the whole has found it more tax efficient to distribute income as dividends, usually subject to the payment of a small salary. To this end, it introduces the concept of "deemed salary" which will be taxed and subject to NIC as if it has been paid as a salary.

In order to retain some logic to this treatment it is necessary to identify the situations in which these rules are to operate. The Government?s concern is that small limited companies are being used to disguise employment, so this is the test which has been applied:-

Where the employee is provided by his Company to an ultimate client on terms which would normally constitute an employment with that client, this is called a relevant engagement and the IR35 rules apply.

Relevant engagements

Where the Company provides the services of a member of staff to a client (either through an agency arrangement or otherwise) and the terms are such that, without the intermediary the individual would be an employee of that client, the new IR35 tax treatment is triggered. It is important to remember, therefore, that it is a test of employment as regards the eventual client that is considered. We are not then saying that the individual is an employee of the client, just that in these circumstances the "relevant engagement" rules will apply.

Income from such work arising from a relevant engagement will be taxed according to the new rules. Clearly, therefore, the planning considerations will depend on the correct classification of the engagement by the Company, so that the new treatment is adopted when appropriate.

Deemed employment or self-employment

As deemed employment will trigger the IR35 rules, it is vitally important to consider what the Revenue will treat as being employed.

The entire IR35 site is available at inlandrevenue.gov.uk

It would be unwise indeed to pin all hopes on a contract effectively bought "off the shelf" describing a self employed engagement. The parties to the contract must behave in such a way as to make it clear that the contract does indeed summarise their working relationship.

Internal Inland Revenue guidance on contracts includes: " The terms of a contract can be written, oral or implied, or a combination of all three." In establishing the terms of engagement the officers enquiring into status are instructed to obtain copies of any contract in existence, and then review the following for additional evidence:-

• Other documentation such as handbooks, procedures manuals and franchise agreements. These may give more information about the terms of the engagement and may also identity the conditions under which the worker is expected to operate;
• Evidence to support oral and implied terms, which might be at variance with the written contract. SE541 warns that the written contract may not have been implemented and that the true contract is made by oral or implied terms. These are identified from verbal agreements at the beginning of the contract, and also from working practices on a day-to-day basis. Guidance highlights "the prevailing practices or conventions of the particular trade or organisation."

Expenses available for deduction

In the calculation of the "deemed salary" certain expenses will be deducted from the income arising from relevant engagements. The most important of these is the deduction for travelling expenses. To be clear the following expenses have been mentioned by the Inland Revenue in various consultations and FAQ publications:-

• Travelling and other expenses deductible under Section 198 of the Income and Corporation Taxes Act 1988;
• Employer contributions to approved pension schemes which attract tax relief in the normal way;
• Gross salary paid plus any employer NIC on both the salary paid and any deemed payments;
• 5% of the gross income from relevant engagements to cover running costs;
• Any other expenses which do not fall within S198 TA, but have another statutory route for deduction, such as payment of professional indemnity insurance.

That really depends on how much your contract rate is. Generally speaking the cost to you will be the additional National Insurance contributions that are payable on the deemed salary. To calculate exactly how this would affect you, click here IR35 calculator

How do I know whether I pass or fail IR35?

This is dependant on your contract itself, and the working practices you have. The easiest way to find out is to ask one of the expert providers for an opinion on your contract. Fees range from around ?125+ VAT for a review of the contract.

Where can I find out more?

Our IR35 resources section gives far more detail, together with expert articles, summary and the latest case law development. Click here to read more.

> Go to 4. Section 660A. What is it? Will I get caught? What will it cost me if I am caught?