"Reasonable steps", penalties and in business on your own account
If you treat your service company as outside IR35, and the Inland Revenue subsequently disagree with the position you have taken, you could be liable for the tax and NICs which have not been paid, for interest on these amounts, and also for a penalty. This penalty can be as high as 100% of the tax and NICs unpaid, though in practice it is often reduced to between 15-50%.
The Revenue have indicated in their IR 35 penalty statement (available at (http://www.inlandrevenue.gov.uk/ir35/penalty.htm) that:
"if you, in your capacity as employer, act prudently by taking all reasonable steps to understand and ensure that your intermediary service company or partnership meets its obligations under the service company legislation, no penalty will be imposed"
This means that if you, as the person running the service company, do not believe that IR35 applies and have taken "reasonable steps" in coming to that view,
you will not face a penalty if the Revenue subsequently disagree with your view.
You will, however, still have to pay any tax, NICs and interest that may be owed if the Revenue are correct.
But not having to pay a penalty may be a significant saving.
So what constitutes "all reasonable steps"?
There have been comments made in the past by the Revenue and Government that if you are uncertain as to your status then you can take advantage of the Revenue's contract opinion service.
Some commentators have interpreted this as meaning that failure to use the service could be regarded as a failure to take all reasonable steps.
Others have suggested that, as an alternative to using the Revenue's service, reasonable steps might require a contractor to use a legal or tax specialist to review your contracts.
However, the PCG has agreed the following points with senior Inland Revenue officers.
The Revenue's contract review service is a public service.
It is not part of the Revenue's compliance machinery although the Revenue opinion will be on file at the Revenue should an investigation occur at a later date.
However obtaining an opinion will not make it more or less likely that you or your company will be the subject of an enquiry.
It is the Revenue's view that a taxpayer would not be considered to have been negligent merely because he or she failed to use either a voluntary service offered by the Revenue or failed to consult with a legal or tax expert on the application of tax legislation, especially in the area of employment status case law. However the individual would have to satisfy himself or herself that IR35 did not apply by considering his/her position in the context of the legislation and the relevant case law.
The PCG considers that a tax-payer, who is seeking to take "reasonable steps", will therefore follow one or more of routes 1, 2 and 3 below to determine what his position is in relation to the application of IR 35:
Route 1: Satisfying yourself by a review of the legislation and your own position
As explained above, the Revenue accepts that an individual can have taken reasonable steps without needing to follow either Route 2 or 3.
Reasonable steps would involve each of the following:
Familiarising yourself with the relevant legislation.
In the case of IR 35 this would include reading and referring to copies of Schedule 12 of the Finance Act 2000 and of the related social security legislation the Social Security Contributions (Intermediaries) Regulations 2000 (Statutory Instrument 2000 No 727) - both of which are available on the Revenue's IR 35 web site at http://www.inlandrevenue.gov.uk/ir35/index.htm. The legislation is, however, not an easy read and you may want to refer to an available text book such as Anne Redston's IR35 Personal Service Companies,( available from http://www.abgweb.com)
Familiarising yourself with guidance as to the main status tests and issues relating to employed and self employed status.
This could include:
Reading the Revenue's February 2000 Tax Bulletin: Guidance on the application of employment status rules to workers using intermediaries and the Revenue's IR 35 FAQ's (also available on the Revenue's IR 35 web site)
Subscribing to membership of a group like the PCG and taking advantage of the resources relating to IR 35 and the discussion forums, where members can benefit from the experiences of a large number of other people affected by IR35.
Reading around the topic on forums such as accountingweb (at http://www.accountingweb.co.uk/tax/ and using available text books.
Armed with this background you should then consider where you stand with regard to IR 35, looking at both your current contract(s) and your general business and personal circumstances.
This would include considering how your contract matched up against the main indicators of a self employment relationship such as a lack of mutuality of obligation, a right of substitution, taking financial risk and the client not having any rights of supervision direction and control;
Considering whether your relationship with your client includes any factors which may be indicative of employment, such as the client having the right of supervision direction and control, the lack of any financial risk or other factors such as being provided with employee-like benefits (use of a company car, share options, holiday and sick pay rights or even pension benefits etc);
If you have neither a key determinant which makes it clear that you are "self-employed" and thus outside IR35, or any strong indicators of employment, you are in the grey area between the two;
It is then useful to assess whether you are in business on your own account.
For details of how to evaluate this see the separate section below;
When you have come to a view, consider using the PCG's status questionnaire.
If the questionnaire arrives at a totally different conclusion then you should consider what the reasons might be.
It may be that you have placed undue reliance on one particular feature of your contract or business set up.
Or it might be that the questionnaire does not take account of some key additional information that you have used.
You should then document what your view is of your status and what are the key factors that lead you to this conclusion.
This is extremely important, as it may be six years before you are asked by the Inland Revenue to explain why you think you are outside IR35.
It is important to note that this "self assessment " approach must be carried out objectively.
It would not be acceptable just to go through the motions without any realistic attempt to reach an objective conclusion.
Mere window dressing will of course be insufficient.
Route 2: Taking professional advice
In most cases the person consulted will be a qualified professional such as a member of the Chartered Institute of Taxation, a Chartered Accountant or a lawyer.
These professionals are obliged by their professional institutes not to give advice unless they have the requisite skills.
If you take advice from others, then you should satisfy yourself that they have adequate experience of the tax and employment law relevant to IR35,
and for your own protection you may also want to ensure that they have adequate Professional Indemnity Cover.
Route 3: Seeking Inland Revenue clearance
The Inland Revenue have given advice in their Tax Bulletin article issued in February 2001 as to how to obtain an opinion from the Revenue.
This is available on the Revenue's IR 35 web site at http://www.inlandrevenue.gov.uk/ir35/index.htm.
In addition to the information requested in the Tax Bulletin, the PCG also recommends that you send the Revenue any relevant evidence that you are in business in your own account.
In business on own account
When considering the issue of being in business on your own account and other personal factors that might influence the overall picture, issues the contractor should consider include:
Whether your company has its own office facilities - either at home or in dedicated offices - and the extent to which they are used for business activities.
Ideally they should be used not just for company administration purposes but also for carrying out chargeable work for clients?
The extent to which your company has invested in office equipment in recent years and the extent to which the equipment has been used for both company administration and client work?
Whether your company is able to work for more than one client at a time? If so, the extent to which it has done work for clients in addition to any main contracts in recent years and whether it is likely to happen in the future?
What other business activities has the company engaged in, in recent years - for example selling systems, creating web sites?
Are such activities part of the company's basic trade or would they constitute a totally different trade to the main contracting activities?
For example contracting as an IT systems expert and selling systems could be all part of the same trade while a second business stream that consisted of renting out property would be a separate trade.
The steps your company has taken to market itself to potential clients, for example using yellow pages, direct marketing, a company web site etc?
Whether the company has invested in training or in research and development of new products or services in recent years?
Whether the company has badges of corporate identity like:
Company phone/fax/e mail addresses and numbers?
Company business cards and marketing material?
Company web site?
A company data protection registration?
Does the company have employer's and public liability insurance and, possibly, professional indemnity insurance?
Is the company registered for VAT?
Does the company have a data protection registration?
Is the company registered to the quality standard ISO 9000, or to Investors in People or any similar business related schemes?
Has your company received any Government grants or loans that are available only to businesses or sole traders and not to employees.
What has been the nature of the company's past contracts? Would they have fallen inside or outside IR 35?
What is likely to be the nature of any future contracts?
Bear in mind that the length of the contract with a client may have some bearing on the issue of being in business on your own account as a longer contract may weaken the influence of personal factors.