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Special tax and NICs rules apply to the earnings of a worker
- who provides services for clients under a contract between an intermediary and a client of the intermediary, and
- who, if the contract had instead been between the worker and the client, would have been treated as an employee or office holder of the client.
The special rules are commonly known as "IR35", from the reference to the original Budget press release in 1999 that announced the changes.
Personal services through intermediaries
The term "intermediary" refers to a service company, or to a partnership, that supplies workers to provide direct services for its clients. The "intermediary" may have a single employee, or it may have twenty or more employees, as in the case of "composite" service companies.
However, whether a service company or partnership must apply the special tax and NICs rules depends critically on the employment status that would apply if the worker supplied to the client were employed directly by the client. This decision uses the established criteria for determining employment and self-employment. It must be noted that the employment status decision must be made by the service company, not by the client.
The workers to whom the IR35 rules apply, based on the guidance given in the CWG2(2006) booklet, are as follows:
Where the intermediary is a service company
Individuals working through a service company who have
- beneficial ownership of, or entitlement to acquire rights entitling them to receive, more than 5% of the ordinary share capital of the service company, or
- possession of, or entitlement to acquire rights entitling them to receive, 5% of any distribution made by the company, or
- received, or could have received, payments or benefits from the company which are not salary but could reasonably be taken to represent payment for the services they provide to clients.
Where the intermediary is a partnership
Individuals working through a partnership where
- an individual worker, or persons connected with the worker, are entitled to 60 per cent or more the partnership profits, or
- all or most of the partnership's income in the relevant tax year is derived from the provision of personal services to a single client or associate of that client, or
- the profit sharing arrangements in the partnership provide for the income of any of the partners to be based on the amount of income generated by those partners through personal services to clients.
However, the IR35 rules do not apply where
- the client is an individual and not in business (e.g. householders), or
- the worker is only entitled to receive earnings from the intermediary that are subject to PAYE and Class 1 NICs and to no other income or capital from the intermediary.
Calculating the deemed payment
If a worker works under contracts between an intermediary and its clients that would have been employment if the contract had been instead between the worker and the client, the service company or partnership should pay a salary throughout the year to the worker, from which PAYE tax and NICs must be deducted and paid. A specially defined calculation is included in the IR35 rules that compares the salary, expenses and benefits received from the intermediary with the payments received by the intermediary from the client. The result of this calculation is known as the "attributable earnings" from the contracts if it reveals that the worker has paid insufficient PAYE tax and Class 1 NICs during the year.
If there are "attributable earnings" from the contracts, the amount is treated as if it were paid to the worker on the last day of the tax year and, as a result, must also be subjected to PAYE tax and Class 1 NICs, payable to the Collector by 19/22 April immediately following. This "imaginary" payment is known as the worker's "deemed remuneration". To ensure compliance, all employers, including service companies, are required to answer the following question on the P35 Annual Return:
Do the rules relating to services provided through an intermediary (sometimes known as IR35) apply to any work carried out by any worker listed on this return?"
If 'Yes', can you confirm that either sufficient amounts of employment income have been paid to reduce the deemed payment to nil or that a deemed payment has been included on their form P14?
The IR35 legislation defines precisely, step-by-step, the way in which the "attributable earnings" or "deemed remuneration", if any, is calculated at the year-end. The procedure is as follows:
- The total value of all payments and benefits (e.g. car or living accommodation) that were received by the intermediary from all of the worker's relevant engagements in the tax year, reduced by 5% to cover the intermediary's general business expenses.
PLUS
- The total value of any payments and benefits (e.g. car or living accommodation) that the worker has received under the relevant engagements other than from the intermediary, e.g. direct from the client, and that have not already been taxed under PAYE or reported by the provider on form P11D.
LESS
- The total amount of any business expenses that were incurred "wholly, exclusively and necessarily" in the performance of the contracts, that were reimbursed by the intermediary to the worker, and that would not have been taxable or that would have qualified for tax relief if the contract had been between the worker and the client. (Examples of such expenses are: travel and subsistence expenses reimbursed by the intermediary to the worker, mileage allowance relief for a car provided by the intermediary, that the worker could have claimed if the contract had been between the worker and the client and the car had not been a company vehicle.)
LESS
- The total amount of capital allowances claimable by the intermediary that the worker could have claimed if the contract had been between the worker and the client, i.e. for plant or machinery that was necessary to fulfil the contract with the client.
LESS
- The total amount of contributions to an approved occupational or personal pension scheme made by the intermediary for the benefit of the worker.
LESS
- The total amount of secondary Class 1 NICs that have been paid and Class 1A NICs that will be paid by the intermediary in respect of the pay and benefits to the worker.
LESS
- The total value of
- payments from the intermediary to the worker, other than those already deducted at step 3, from which PAYE and Class 1 NICs have been deducted, including mileage and passenger allowances and payments for the worker's own vehicle that are exempt from any tax charge, and
- benefits from the intermediary to the worker, other than those already deducted at step 3, for which the intermediary has a Class 1A liability.
If, at this point, the result is nil or negative, there are no "attributable earnings" for the tax year.
If the result is positive:
- Calculate the amount that, together with the secondary Class 1 NICs payable in respect of it, equals the amount at step 7. (For example, if the amount at step 7 were £;11,280, the step 8 calculation would give £;10,000 (i.e. the employer's contribution on £;10,000 would be £;1,280 at the 2006/07 rate of 12.8%).
The result is the worker's "attributable earnings" for the year. Whether or not it is actually paid to the worker, it is "deemed" to be paid to the worker on the final day of the tax year and must be subjected to tax and NICs through the payroll as part of the worker's earnings in the final pay period of the tax year.
Payment must be made to the Collector by 19/22 April and the deemed payment, tax and NICs included in the year-end forms P14 and P35 returns that must be filed by 19 May. Interest is charged if payment is not made by 19/22 April but, if the deemed remuneration calculation cannot be finalised by 19 May, provisional figures must be returned and a note attached to the P35. No penalties will be imposed as long as supplementary forms P14 and P35 and any outstanding tax and NICs are provided by the following 31 January.
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Further Information:
www.hmrc.gov.uk/manuals/nimmanual/nim02445.htm
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