This week has seen the publishing of the new ‘business entity’ test by HMRC. These tests and the IR35 operational approach was the subject of discussion at a meeting of IR35 specialists from both profession and industry, and HMRC, held yesterday, which Andy Vessey was a participant.
None of the questions really come as any great surprise and are variations/expansions on well known historical themes. It is, however, the allocation of points to some of the answers to these questions that do appear imbalanced.
The tests that are guaranteed to put a freelancer at the bottom of the risk pile are those that evidence an actual lack of personal service, i.e. engaging assistance, invoking a right of substitution or sub-contracting out work.
The detailed tests together with the associated scoring system is reproduced below:
| Test 1 | Business Premises test | Does your business own/rent separate business premises which are separate from your home & client’s premises? | Yes = +10 |
| Test 2 | PII test | Do you need professional indemnity insurance? | Yes = +2 |
| Test 3 | Efficiency test | Has your business had the opportunity in the last 24 months to increase your business income by working more efficiently e.g by finishing the work/project earlier than projected but still receiving the full agreed payment?
For example you originally agreed with the client/engager that the work would take 3 months & cost 10,000 but you finished in 2 months & still received the full 10,000 at the end of the 2 month period. |
Yes = +10 |
| Test 4 | Assistance test | Does your business engage one or more workers who generate at least 25% of your business turnover annually? | Yes = +35 |
| Test 5 | Previous PAYE test | Have you been engaged on PAYE employment terms by your current client/end user within the last financial year with no significant changes to your working arrangements?
If you are doing the same work you should answer yes to this question. Current engager also includes working at a different location owned by your engager or working at a different company but which is connected, e.g part of the same group. |
Yes = -15 |
| Test 6 | Advertising test | Has your business invested over £1,200 on advertising, excluding entertainment in the last 12 months? | Yes = +2 |
| Test 7 | Business Plan test | Does your business have a business plan with cash flow forecast that is regularly updated, and a business bank account which is separate from your personal account and identified as a business bank account by the bank? | Yes = +1 |
| Test 8 | Repair At Own Expense test | Would your business have to bear the cost of having to rectify any mistakes? | Yes = +4 |
| Test 9 | Client Risk test | Has your business been unable to recover payment for work done during the last 24 months in excess of 10% of annual turnover? | Yes = +10 |
| Test 10 | Billing test | Do you invoice for work carried out prior to being paid & negotiate payment terms? | Yes = +2 |
| Test 11 | Personal Service test | Does your business have the right to send a substitute? | Yes = +2 |
| Test 12 | Substitution test | Has your business hired anyone in the last 24 months to do the contracted work you have taken on? This could be demonstrated by sending a substitute in your place or by sub-contracting, but in both cases your business remains responsible for the work & for paying the substitute or sub-contractor.
You can still pass this test if you had to notify the end client of the name of the individual you sent as a substitute. |
Yes = +20 |
Scoring:
High risk = 0 – 10 points
Medium risk = 10 – 20 points
Low risk = 20+ points
Why has the ‘Business Premises’ test only been attributed 10 points? A business operating out of premises distinct from a contractors’ residence is a major financial commitment and, if actually owned, investment. Ownership of such a business asset has always been viewed as a firm indication of a genuine business being operated and it surely deserves greater weighting being attached to it.
Advertising costs in excess of £1,200 represent significant expenditure for a small business, yet it only achieves the same score as the ‘Billing’ test. Whilst the two activities are indicators of business activity, the importance attached to invoicing is disproportionate in comparison to committing business revenues to advertising.
These pilot tests are designed to help freelancers gauge their IR35 risk exposure and whilst everyone would wish to fall within the low risk category the reality maybe that medium risk is the best that can be achieved. One incidence of a substitute being used, however, would appear to vault a contractor to the desired side of the risk fence. As HMRC are focusing their attention on high risk cases perhaps a medium risk score isn’t all that bad, particularly if there are other positive factors, outside of this test, in the contractors’ favour. Furthermore, HMRC will not be using the ‘Business Entity’ test as part of their risk criteria for selecting cases for review.
HMRC emphasise that it is important that the ‘Business Entity’ test should not be viewed in isolation but rather in conjunction with the associated guidance, which is available on HMRC’s website (see business entity test guidance). There is a danger that taking the test out of context, i.e. without reference to the guidance, will result in a skewed and distorted view of the essence of each test and the resultant scores.
In addition to the ‘business entity‘ test a number of other initiatives are to be piloted which are designed to reduce uncertainty and provide greater certainty for the majority of freelancers. These are as follows:
Six Scenarios
These will help explain when IR35 would and would not apply and the reasons why. They will also explain factors that should be considered when contemplating whether IR35 applies.
Guidance
Explanations will be provided as to how the piloted products work and also what a personal service company needs to do if they are caught by IR35.
IR35 Helpline Improvements
Both HMRC’s helpline and review service will be manned by specialist staff who will be independent of the Revenue’s compliance teams. Whilst HMRC will aim to reassure contractors that there will be no reporting of information to any other part of the department, there will be many that will still remain sceptical. At yesterday’s meeting however, the HMRC officer with responsibility for the contract review service based in Northampton maintained that once a contract review was concluded, for whatever reason, then the papers are simply put away.
Contractors will be able to speak to specialist staff to review their contracts and if deemed to be outside of IR35, will be issued with a certificate containing a unique number which will be valid for 3 years. This can then be produced upon any subsequent IR35 review causing that review to be suspended to allow time for the previously supplied information to be considered. Provided this is the only area of risk and the original information provided is genuine, then the review will be closed.
For anyone wishing to have their contract reviewed by HMRC it is worth noting that for the Revenue to give a conclusive opinion they may well need to contact the end client.
HMRC will not give an opinion on contracts that have been drawn up but not yet enacted.
In conjunction with these initiatives, HMRC will also pilot a new operational approach:
- Three new specialist teams, consisting of approximately 12 members each and with a specialist status inspector attached/embedded within them. These will be based in Salford, Croydon and Edinburgh, although reviews undertaken by these teams will not be geographical;
- New risk assessment process targeted at those who are in ‘disguised employment’. The risk assessment will be done outside of the three specialist teams but following the advice of IR35 specialists;
- Within the opening review letter sent to a contractor will contain the question, ‘Have you considered IR35? If so why do you consider yourself to be outside of IR35? Please provide evidence to support this answer.’ Where such satisfactory evidence is provided then HMRC will hope to close down the review at an early stage and there are also plans to exempt that business from an IR35 review for the next 3 years. HMRC have already targeted those high risk businesses that will be the first recipients of this letter in approximately 2 weeks’ time.
- Where satisfactory evidence demonstrates that a contractor is ‘in business’ then HMRC will bring any review to a close, and
- In order to reduce delays in IR35 enquiries, HMRC will use their powers at an early stage to obtain information necessary to progress the enquiry. This could mean that third party information will be sought sooner rather than later.
All in all, probably not a bad effort but the proof of the pudding will be the eating thereof and judgement will have to be reserved until April 2013 when we learn of the end of term report. It is possible that another meeting will take place mid term to enable feedback as to what works and suggestions as to how HMRC‘s processes can be further improved. Contractor Weekly would therefore welcome reader’s experiences of these initiatives, good or bad, to help continually improve the administration of IR35.
What is your score on the test? Share your result in the comments section below.
I can’t see any questions regarding the number of simultaneous contracts someone is working on, the overall number of clients that the contractor has done work for in, say, the last year, or the number of revenue streams a company has.
Struggled to get 5 there….guess I’ll be paying a lot more tax next year then!
Test 9 seems to be unfair marked at 10% of turnover. Employees are at no risk at not being paid, and during administration, they also are preferential creditors and normally receive a good proportion of their pay. Normal businesses could only receive a few pence in the pound. This has happened to my business, but longer ago than 24 months. However, I don’t see that the risk of it happening again has changed since then. Indeed, for one of our clients we have only just received payment from December (and that was touch and go), so 5 months overdue. Again, a permanent employee would not have to worry about this.
Another item that appears to be missing from the list, is having multiple clients. My business provide services to multiple different companies, sometimes in the same industry. Permanent employees are never allowed to perform this, but as a business entity, it is your entitlement to be in business in your own right. Surely this should warrant a reduced level of risk?
I work in an office at a suppliers (not my clients office) can I have 5 points? These questions are ridiculous and don’t clarify anything unless you score one of the big point questions.
Client risk test: Within the last 2 years I had to resort to legal involvement to receive payment for over 10% of invoiced amount. As I was successful, do I fail that test? In 6 months time, when the 2 year period is over, although my work method will be the same, does my status suddenly change?
As I have said before, if the Government believes all single person companies should be within IR35 (which the questions suggest), then find some balls and change the law accordingly.
Where are the tests about receiving paid holidays, training, promotions, medical insurance or any of the other benefits paye employees receive. If you want to label me an employee then give me the perks, can’t have it both ways. Oh wait, you’re HMRC, yes you can.
Does the separate business premises have to be solely owned/occupied?
Thee doesn’t seem to be anything that considers any time and cost spent to attend training and seminars at your own (or your own company’s) expense?
#19 but only because I was unable to revover money for work done, but that will drop off in next 12 months. I just had some building work done and they would also fail this test, so it seems a poor judgement on being a ‘real’ business.
This list shows how good HMRC are at wasting taxpayers money. They have spent months putting together a useless guide. unless you score the -15 figure it’s all pretty meaningless. Maybe I will get one of my contacts to fill in for a week every two years while I take a holiday.
I score 6, 23 or 23 depending on how these tests and my circumstances are interpreted for details: http://blog.principia-it.co.uk/2012/05/09/ir35-help/
Okay, that should be 6, 13 or 23 🙂
So the Government only considers you a real business if you cant recover money..OMG..!!
This is the true state of the united Kingdom..Just cause the Government cant recover their dues does not mean real private businesses cant!!
If a contractor is done for not being outside IR35 then the client who used him/her should also be done for it…as what is happening now is that companies are getting rid of people and employing contractors and then treating them like employees while saving cost.
Why HMRC or Government is not looking in to these practices but keep squeezing the small guys who just wants to work and make living by keeping every peanut rate they get outside full time employment as they are taking the risk of being out of the door with days notice with no sick pay or holiday or other benefits.
These types of practices by businesses surely screwing up the economy and social fabric by reducing fulltime employment forcing people to go contracting that in turn creates uncertainty in their life and they spend less and the cycle keeps on going…
This is deliberate entrapment. We don’t get paid holiday or sick days, no other benefits that permanent employees enjoy but they want to tax us as if we do.
To top it all off you will get some 12k a year muppet on the phone when you try and call HMRC to argue your case. Still, on the +ve side whether you are high medium or low risk it is not necessarily an indication of how you will be taxed (hmmm) – seems to me what they actually mean is they intend to apply it inconsistently.
Who on earth was behind designing the point system for this, Test 11 & 12, unless there has been a need to send a substitute then its not good enough that you can?! Advertising revenue is irrelevant to many contractors, I’ve never had a need to pay for advertising because work and clients come through word of mouth, networking, agencies etc and shouldn’t mean the facts are any less relevant.
IR35 surely can’t be a cost effective/time effective thing to police, the majority of contractors are quite genuinely not employed by their client, do not receive any benefits of being employed such as paid sick leave or annual leave. Working arrangements on contracts within a financial year may not change, that doesn’t mean that suddenly you’re an employee, some contracts just consist of many projects on a rolling basis, or are for projects which take a year or 2 to complete.
I do wish the HMRC would spend more time getting the tax owed out of the large companies like Vodafone etc instead of negotiating drop in the ocean arrangements that means they get away with paying nothing like what they truly owe and stop trying to batter the small 1 person or couple of person companies who are not doing anything wrong.
Totally agree with the self-training point above.
Pleased that longevity of contracts/extended contracts is not deemed to be a negative.
However – there’s no mention of MOO here – I was released with just a week’s notice an dno ceremony whatsoever, plus I was offered renewals over 30 times in my last engagement and each time I had a choice as to whether to accept. ALos, my hourly rates went up, down , was cut by 10% once, 5% once, and on occasion I was forced to take time off at very short notice to save the client money. How many permanent employees have to accept that! Surely the IR35 test is missng some major key issues.
(apologies for previous typos 🙁 )
On Test 4 – my business (limited co.) employs ME and I generate all of the revenue – is that therefore a score of +35 ???
A number of MPs and politically involved people, as well as some celebrities, offer their services as after dinner speakers and invoice through their own Limited Company. As a speaker they have to “work” at the clients chosen location and cannot substitute someone else in their place. They will have to carry out their work at a time defined by their client. They cannot engage somebody to generate more than 25% of their annual turnover. They cannot increase business income by being more efficient and finishing early. They will not need professional indemnity insurance.
Will they be scrutinised in the same way as contractors?
If so, let’s get them on board to apply some pressure.
If not, why not?
I am employed by my limited company. I am the one who generates 100% of the businesses income does this mean limited company people score +35 on test 4. ????
@james
Sadly not. It’s not a very well worded question, but the additional guidance states:
“If your intermediary is a company, these workers need to be people other
than directors or shareholders of the company.”