For a number of years, it has been common practice for individual contractors to supply their services through an intermediary, typically a personal service company or a managed service company. This is particularly common in knowledge based areas, such as IT, telecoms, engineering etc. The benefit of structuring the arrangements in this way are two-fold – firstly, there is the greater flexibility that a consultancy arrangement provides, but more importantly it makes it possible to generate significant tax savings for the individual.
The use of consultancy arrangements increased during the 1990s, and in 2000 the UK tax authorities introduced rules (known as the IR 35 rules) to prevent people avoiding income tax and national insurance contributions ("NICs") by providing their services through an intermediary when, if the services had been provided directly by the individual to the client, the individual would have been treated as an employee for income tax and NIC purposes. In these circumstances the client would have an obligation to account for PAYE and also both employer and employee NIC.
The IR 35 rules operate by requiring the intermediary to account for income tax and NICs under the PAYE system.
Unfortunately, what started life as a simple press release has become a notorious and difficult area of law. In particular, to avoid falling within the IR 35 rules, it is important to ensure that the arrangements between the client and the intermediary (and also between the intermediary and any agency that may provide services to the client) are structured to minimise the risk of IR 35 applying. Whilst the reality of the arrangements is important, it is particularly important that all of the relevant contracts are drafted in such a way as to reduce the risk of IR 35 applying.
The importance of the terms in the contracts was emphasised in a recent decision on IR 35 by the UK Tax Tribunal. This decision is very helpful, as it provided the court's views on the factors it considers important to support a genuine consultancy arrangement, the factors which suggest an employment arrangement and the factors which are neutral. Also, the court confirmed that the most important contract is the contract between the client and the intermediary and it analysed this agreement in detail in reaching its decision, which was in favour of the individual.
As we now have recent guidance from the court on the contractual terms that it would expect to see in a genuine consultancy arrangement, we would recommend that consideration be given to reviewing the current contractual arrangements which a company may have with consultants/intermediaries to confirm whether they accurately reflect and are in accordance with this guidance, and also whether it might be possible to reduce the risk of an IR 35 challenge by amending the existing contracts.
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