Contractor guidance on HMRC’s six IR35 example scenarios

Warning! Note that the business entity tests have been abolished, effective from April 2015. HMRC will continue to honour its commitment not to investigate for three years contractors who had previously taken the tests and secured a low risk score.

Limited company contractors can use HMRC’s six IR35 example scenarios to help them evaluate their IR35 status. The scenarios are intended by HMRC to illustrate when and why IR35 will apply to a specific contract, and when and why it will not.

HMRC says that the IR35 example scenarios are independent of its business entity tests. This is because the scenarios focus on individual contracts, whereas the business entity tests are designed to look at a limited company contractor’s business as a whole.

The six tests replace the original IR35 risk scenarios published when IR35 was introduced in 1999, which featured high risk ‘Gordon’, medium risk ‘Charlotte’ and low risk ‘Henry’. However, the IR35 landscape has evolved considerably since ‘Gordon’ and his friends’ stories were published – contractors are now more IR35 savvy and case law has helped clarify the legislation.

The example scenarios are unlikely to assist experienced contractors to determine their IR35 status, but may be helpful for new contractors seeking a general understanding of IR35 and when they may need to ask for expert help. However, for both novice and inexperienced contractors, Contractor Calculator’s free IR35 test is likely to provide more accurate, individualised results.

The example scenarios are unlikely to assist experienced contractors to determine their IR35 status, but may be helpful for new contractors seeking a general understanding of IR35 and when they may need to ask for expert help

HMRC has gathered together all of its IR35 guidance and links to online resources into a single document, Intermediaries Legislation (IR35) - Working through an intermediary, such as a Personal Service Company, published in June 2014.

How to use HMRC’s IR35 example scenarios

HMRC has provided a selection of examples of contractors inside IR35, outside the legislation, and on the borderline. It also includes one example of a contractor starting with a client outside IR35, who subsequently falls within IR35, presumably to account for situations similar to the JLJ Services case. The examples are categorised as follows:

  • Outside IR35: Emma and Hamish
  • Borderline: Juanita
  • Inside IR35: Barbara and Praveen
  • Outside then inside: Costas.

For each of the examples, HMRC includes:

  • An overall summary
  • The facts of the case
  • The reason for its conclusions about the contractor’s IR35 status.

HMRC’s guidance points out that it does not seek to bring out all the factors that could be relevant. But that approach leaves IR35 specialists and experienced contractors wondering why HMRC has chosen some factors whilst ignoring other, seemingly more important, ones.

Example scenarios outside IR35 ? Emma and Hamish

Both Emma and Hamish work via an agency, although Hamish bills for his time whereas Emma is on a fixed price basis. Emma can’t substitute, but Hamish can and, although he has not exercised the substitution clause, he has two other named contractors as potential substitutes.

According to HMRC’s analysis, the key lessons and IR35 factors putting Emma and Hamish outside IR35 are:

  • Personal service: Hamish can send a substitute
  • Control: Emma’s client does not exercise sufficient control to indicate her contract may be inside IR35
  • Financial risk: Emma’s fixed-price invoicing basis and Hamish’s expenditure on equipment both demonstrate financial risk.

HMRC notes that, because Emma is highly skilled, the fact that the client does not tell her how to work is a neutral indicator, which would appear not to agree with case law. Both would fit the classic contractor profile except that Emma charges on a fixed-price and not hourly basis, and Hamish invests heavily in his own equipment.

Example scenarios inside IR35 – Barbara and Praveen

Barbara and Praveen both fit the profile of classic contractors inside IR35. They are classic contractors because they are both highly skilled knowledge workers, work at their client’s site full time with equipment provided by the client, secured their assignment through an agency, bill by the hour and Praveen works on 12-month contracts.

What places both of them inside IR35 is the level of control the client exerts and the expectation of personal service. Other factors that firmly place Barbara inside IR35 are that she is a ‘tail-end charlie’, expected by her client to work on a range of tasks, and not on a specific project.

Praveen is told what to do and has daily meetings about how he does it, plus both he and Barbara have to request time off.

Because of their IR35 status, both contractors would be expected to pay themselves a salary, deducting income tax and National Insurance Contributions (NICs) via their limited company payroll, or they should make a deemed payment before the end of each financial year.

Borderline case – Juanita

Although Juanita is HMRC’s borderline scenario, the fact that she has worked for the same client for eight years could make it very difficult for her not to slip into habits that would brand her as ‘part and parcel’ of her client’s organisation, and potentially inside IR35. The factors that HMRC explains put her in the borderline category include:

  • Juanita has a substitution clause but has never exercised it, and it is not clear if the client would accept a substitution; this doubt places her in the borderline category
  • There is an element of control by the client telling Juanita what to do, but not when she must do it, as Juanita can work from home according to her own timetable
  • Other, weaker, factors putting her outside IR35 include the fact that she receives no employment benefits and she invoices for payment for her work
  • Factors putting her inside IR35 include her client’s provision of equipment and her mentoring of client employees, which HMRC feels could point to her being ‘part and parcel’ of her client’s organisation.

The key factor HMRC did not include in its analysis is that Juanita is contractually obliged to rectify mistakes at her own expense, which would normally be a factor putting her outside IR35.

Outside IR35 and then inside – Costas

The scenario created by HMRC to explain Costas’ IR35 status is similar to that of contractor John Spencer in the JLJ Services case.

Costas operates as a classic contractor for the first three years of his relationship with the client, with multiple factors placing him outside IR35, particularly the fact that the client did not control when and how Costas worked.

After three years, however, instead of working on specific projects, Costas finds himself with a roving brief to complete any tasks as directed by his client. At this point Costas was controlled by his client to the extent that it put him inside IR35.

Example scenarios are not set in stone

HMRC does stress that its IR35 scenarios are just examples, and that they are intended to act only as guidance for contractors trying to determine their IR35 status. It has committed to revising and updating the scenarios over time, following feedback from contractors and their advisors.

However, the scenarios have no bearing on how the underlying IR35 legislation will be applied, which remains unchanged. Limited company contractors are well advised to continue to invest in investigation insurance, contract reviews and IR35 best practice. If they recognise factors in the borderline and inside-IR35 scenarios as resembling their own contracts, they should seek professional advice from an IR35 expert.

Updated: Wednesday, April 1, 2015

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