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INTRODUCTION
1.1 ABOUT THIS GUIDANCE
The following guidance is designed to assist in determining
which type of contract will be issued to contractors in different
circumstances and what obligations DMDP has in relation to those
contractors for tax and NI. There are two types of contractual
relationship between DMDP and contractors: the type that is treated
as employment for tax purposes and the type that allows contractors
to be treated as self-employed for tax purposes.
For each type of contract there are Terms of Business for the client
and a contract between DMDP and the contractor which may be either:
For employment (Relevant) (Captured):- Terms
of Engagement; or
For self employment (Not Relevant) (Not Captured):- Consultancy
Agreement
NB: It is important to stress that
the term "Employment" in the context of these contracts is purely used for
the purposes of tax and NI. It does not mean that an individual
working under terms of engagement will be able to claim that
he has a contract of employment and that he is therefore entitled
to unfair dismissal, redundancy, paid eye tests etc. This guidance
relates solely to the issue of liability for tax and NI.
1.2 IR35 TAX REFORMS - FROM 6 APRIL 2000
From 6th April 2000 limited company contractors providing
personal services will have to pay to the Inland Revenue PAYE tax
and National Insurance Contributions on income received from "relevant" engagements.
Those engagements which are considered to be relevant are those
which indicate a relationship between the contractor and the Client
which, in all the circumstances would amount to employment but
for the existence of the limited company.
In determining whether an engagement is a "relevant" engagement
the Inland Revenue looks at all the facts of the relationship between
the contractor and the Client and the contractor and the agency,
if they are supplied to the client through an agency. Their investigation
will include a consideration of the terms of any contract in existence
hut will not be limited to the contract. Therefore if the facts
of the relationship indicate employment but a Consultancy Agreement
has been issued indicating a self-employment relationship this
will not protect a contractor from any claim for PAYE and NIC's
on income received from that engagement.
It is worth noting that the Inland Revenue have
extensive investigative powers and also powers to impose penalties
on those who have failed to pay tax due for a period of six years
after the tax becomes due. Contractors may be considered to be
employed for tax purposes in relation to one or more engagements
and self-employed for tax purposes in relation to others. Also
as a contractor is engaged on an assignment of one month or more
on standard contract terms which appear to meet the definition
of employment he will be treated as employed unless he can demonstrate
a recent work history of engagements with the characteristics of
self-employment. Contracts of less than a month, and cases where
there is a pattern of other work, will be looked at by the Inland
Revenue on a case by case basis.
2. CONSEQUENCES OF EMPLOYMENT/SELF-EMPLOYMENT
Before explaining the differences between employment
and self-employment for tax purposes the following is an explanation
of the consequences of each of these types of contract:
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Employment
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Self Employment |
| Individual |
DMDP is obliged to deduct tax and NI before payment (section 134
ICTA 1988)
. |
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| Limited Company |
(Relevant) (Captured) DMDP pays Limited company gross but limited
company must account for PAYE and NI on income received under such
a contract.
. |
(Not Relevant) (Not Captured) DMDP pays limited company gross and
limited company pays corporation tax on profit.
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3. TESTS TO DETERMINE EMPLOYMENT/SELF EMPLOYMENT
So how do we determine what contract should be issued?
The starting point is to consider the facts of the relationship
between the client and the contractor in any proposed assignment.
We will discuss with the client the basis and method of payment;
the type of work and how or whether it is to be supervised. We
will also discuss with the contractor whether he works or has worked
for other clients; whether he is prepared to quote a fee for the
work and whether he has equipment or facilities which he can provide
in order to do the work. Once we have this information it is then
a balancing exercise to consider what arrangement is likely to
exist.
The following are the tests used by the Inland Revenue
to determine, by means of a balancing exercise, which type of arrangement
exists:
Tests
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Employment |
Self-Employment |
| Control |
Client has the right to tell the contractor what,
when, where and how to do the work. It is this right to control
the work that is important. |
The contractor has the right to decide where,
when and how the work is performed. However some direction
or supervision by a client may be necessary. |
| Substitution |
It is essential that a particular individual
carries out the work. |
The contractor has the right to choose whether
to do the work personally or get a helper or hire somebody
else to do the work. |
| Equipment |
Provision of facilities or equipment or materials
by the client or employer, |
Provision of own tools or equipment and purchase
of materials at own cost. |
| Financial Risk |
Payment for work done and no element of loss
if the work is not completed or materials cost more than budgeted
(commission not included). Also the employer bears the cost
of training the worker. |
Payment by a fixed fee or monthly sum no matter
how long the work takes to complete. The cost of training is
borne by the contractor himself. |
| Opportunity to Profit from Sound Management. |
No ability to affect his income (except by job
related bonuses) by organisation of the work or a reduction
of overheads. |
Efficiency in sound management affects the take
home profits. |
| Dismissal |
Provision for a period of notice of termination. |
Termination will usually be only on completion
of the task or project or if the terms of the agreement are
breached. It is usual to provide for circumstances in which
termination will be justified. |
| Basis of Payment |
Fixed wage or salary and additional payments
for overtime, bonuses, reimbursement of expenses incurred in
the course of work. |
Fee quoted for total job. No extra payment for
expenditure not agreed in advance. Fees may be estimated by
reference to the period the work is expected to take but the
contractor is likely to be bound to the estimated fee. |
| Benefits |
Right to receive sick pay, holiday pay, pension,
benefits and expenses. |
None of these. There is no right to receive pay
for periods when no work is performed and no right to job-related
benefits. Expenses may be reimbursed. |
| Length of Engagement |
A long engagement or open-ended arrangement. |
Usually engaged for the specific project. Possibly
a series of small task-related contracts which may or may not
overlap. |
| Part and parcel of the organisation |
The contractor performs a role which is integral
to the clients organisation e.g. managing staff |
the role is task orientated and the contractor
is not treated as one of the staff. |
| Personal Factors |
The contractor is unlikely to have purchased
facilities to carry out the work at home and is unlikely to
have a number of different employers, |
The contractor has a number of contracts for
different clients and will probably have invested in office
facilities or equipment and pay staff or an accountant to invoice
or provide other facilities. |
| Intention |
If all other factors present a neutral impression
of the contract so that it is not possible to decide whether
it is employment or self-employment, the intention of the parties
will be deciding factor. |
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4. THE APPROACH TO BE ADOPTED IN CONSIDERING WHICH
RELATIONSHIP EXISTS
Once all the factors of the relationship have been
considered it is necessary to stand back and look at the picture
as a whole to see if the overall effect is that of a person in
business on his own account i.e. self-employed, or a person working
as an employee in somebody else's business.
The following quote made in a case called Hall v
Lorimer sums up the process which must be adopted in deciding which
contract should be issued:-
"In order to decide whether a person carries on
business on his own account it is necessary to consider many different
aspects of that person's work activity. This is not a mechanical
exercise of running through a checklist to see whether they are
present in, or absent from, a given situation. It is a matter of
evaluation of the overall effect, which is not necessarily the
same as the sum total of all the individual details. Not all details
are of equal weight or importance in any given situation. The details
may also vary in importance from one situation to another."
NB It is clearly not a simple
exercise to decide which type of relationship exists between
a client and contractor. In the vast majority of cases the
contractors will not fulfil the tests of self-employment. In
every case the contractor, who is concerned about the effect
of the terms of the contract in relation to his tax liability,
will be advised to seek his own legal or financial advice.
5. WHICH CONTRACT WILL BE ISSUED?
It is possible to issue one set of terms of engagement
to cover all assignments which amount to employment. For every
assignment that appears to be self-employment a new Consultancy
Agreement should be issued.
6. CONSEQUENCES OF FAILURE TO ISSUE THE CORRECT
CONTRACT
If an Agreement for Consultancy Services is issued
to a Limited Company contractor and the Inland Revenue regard the
individual as employed there is no direct liability on the agency
or the client for tax and NI.
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