Contractor Doctor: I’ve been outside IR35 and now think I’m caught. What should I do?

Dear Contractor Doctor,

I’m an interim management contractor trading through my own limited company, specialising in turnaround and change projects. I am currently working on a 12-month contract within a government agency.

Until now, I’ve been working outside IR35. However, after coming under pressure from the media and Minister responsible for the agency, my IR35 status has been called into question.

I’ve been operating outside IR35, but now think I might be caught. What should I do?

Thanks

Paul

Contractor Doctor says:

Contractors can be outside IR35 for one period of a contract and, if the nature of the assignment changes, inside IR35 for another period. The JLJ Services ruling in 2011 confirmed that tax tribunals can split contracts into inside and outside IR35 periods if the evidence suggests this to be the case.

The most important step is obtaining and interpreting the evidence to determine whether Paul’s original status as a genuine contractor in business on his own account has been changed to that of a disguised employee.

The key tests of employment – control, substitution and mutuality of obligation – should be applied, and if Paul passes any two of them, legal precedent confirms he is not a disguised employee and must be found outside IR35.

It is possible for Paul’s assignment to have changed following the media story because he may have come under considerably greater control by ministers. Ideally, his contract should have been changed to reflect the change in conditions, but an IR35 investigation will always focus on the real relationship. The Autoclenz ruling demonstrated that a tribunal can ignore written contracts in favour of the actual working conditions.

A potential change of IR35 status – action plan

There are three key issues for Paul to consider at this point:

  • Establishing his IR35 status, and if it has changed, determining exactly when
  • Making provision for making a deemed payment (extra tax) for any periods that he was inside IR35
  • Determining his contracting, IR35 and financial strategy going forward.

Most importantly, Paul should not allow himself to be rushed into any precipitous actions, such as going on the client or agency payroll as a Pay As You Earn (PAYE) employee, as a result of pressure by his ministerial client or the media.

He has a contract between his limited company and the agency supplying his services to the government department client, and unilateral changes by the client could be a breach of contract.

IR35 status – the tests of employment

Paul’s first step should be to take Contractor Calculator’s Free Online IR35 Status Test for Contractors, which will provide him with an indication of his IR35 status. He can run several versions, including before and after the circumstances that led him to change his working practices. If the results are borderline or a fail, he should seek professional advice from an IR35 specialist.

Although office holders and officers are considered to be inside IR35 by default, the exact details of Paul’s contract and his working conditions are not known. His contract could have been structured such that he is not technically an officer, and so he may be under little or no control by his ministerial client. Although it is unlikely he could send a substitute, control has many nuances, highlighted by IR35 cases of 2011; so if he fails that employment test, then he is not a disguised employee.

The JLJ Services ruling in 2011 confirmed that tax tribunals can split contracts into inside and outside IR35 periods if the evidence suggests this to be the case

Whatever the specifics, Paul would be wise to gather evidence of his working relationship with his client before and after the media coverage and ministerial pressure that might have forced him to change his working practices. This could ensure he is put outside IR35 for the period before ministers took greater oversight, and he can make financial plans for any subsequent periods after that in which he is inside IR35.

Making financial provision for periods inside IR35

Borderline contractors are often tempted to ignore IR35 and proceed on the basis that they may never be caught. However, because Paul’s employment status has been called into question by the very stories which changed it, he would be wise to take precautions.

This includes:

  • Setting aside cash in the company bank account to pay additional income tax and National Insurance Contributions (NICs) due under IR35’s deemed payment. Although, in practice, Paul should simply pay himself a salary for the period that he’s inside IR35, because it is likely to be neater from an accounting perspective
  • Taking out IR35 insurance, or joining an organisation such as PCG with which insurance comes as part of the membership package
  • Setting aside cash to fund any back taxes, penalties and interest in case a tribunal rules Paul to be inside IR35 before the media story broke.

However the scenario unravels for Paul, he is likely to suffer a significant reduction in his net income and he may wish to plan his family and lifestyle finances accordingly.

Contracting strategy

If Paul finds himself forced into making contractual changes, or even having to change his trading vehicle from a limited company to fixed-term employment contract, he may wish to consider other contracting options. After all, as a small business, he can choose his clients and, given his level of expertise, finding a new contract is unlikely to be problematic.

If his government department client is insisting on termination so that Paul has to become an employee, that leaves him free to pursue other options which may not leave him so out-of-pocket.

Good luck with your contracting!

Contractor Doctor

Published: Tuesday, February 28, 2012

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