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Risky Business?

12 October 2012

The intermediaries legislation (known as IR35) effects individuals who provide consultancy and other personal services to their clients through companies or partnerships on terms that would have made them employees if they had been engaged directly by the client.

HM Revenue & Customs have been redesigning their approach to identify potential intermediary cases and have introduced a new risk based points system, which uses a series of business entity tests to determine whether they should be taking a closer look to see if the IR35 legislation applies.  After all it is worth their while because if IR35 does apply then HMRC stand to collect more tax! 

However, if you know what these tests are, the it is possible for you to turn the tables and limit your exposure.

The New Approach

In order to gauge how likely it is that they need to check if IR35 applies to you, HMRC apply a risk based approach.  In order to determine if you are low, medium or high risk HMRC may write to you and ask a series of questions (known as business entity tests).  Each answer will attract a number of points and the total number of points determines which risk category you are in.  If you are in a low risk category, HMRC have indicated that they will most likely close their enquiry.

Note that the business entity tests help determine the risk of HMRC enquiring into your IR35 status, they do not give a definitive answer as to whether or not IR35 actually applies.

The business entity tests are voluntary, you are not required to provide answers to HMRC.  Not providing answers however could lead to HMRC opening a fuller enquiry into the intermediary’s tax affairs if they believe that IR35 could apply.

Business Entity Tests

The business entity tests cover 12 key areas each with different point scores.

A test score of less than 10 points means you are high risk, between 10 and 20 points is medium risk and over 20 points is low risk.

The typical questions asked are (a 'yes' answer will score points): 

  1. Business Premises – does your business have separate premises from your home? (10 points)
  2. Professional Indemnity Insurance – do you have PII insurance? (2 points)
  3. Efficiency – has your business had the opportunity to increase its income by working more efficiently in the last 12 months? (10 points)
  4. Assistance – do you engage workers who bring in >25% of your yearly turnover? (35 points)
  5. Advertising – have you spent > £1,200 on advertising in the last year? (2 points)
  6. Previous PAYE – were you previously employed by the end client? (minus 15 points)
  7. Business Plan – do you have a business plan/cashflow forecasts which you update regularly and a separate bank account? (1 point)
  8. Repair at own expense – would your business have to bear the cost of correcting errors? (4 points)
  9. Client risk – has your business had any bad debts in the last year that account for > 10% of turnover? (10 points)
  10. Billing – do you quote fees and negotiate payment terms before undertaking any work? (2 points)
  11. Right of substitution – do you have the right to send a substitute to do the work? (2 points)
  12. Actual substitution – have you hired anyone in the past year to do the work you have taken on eg substitutes or subcontractors? (20 points)

The answer to each test would need to be backed up by documentary evidence.

If HMRC do look into your IR35 status they will look at the bigger picture, including the length of the engagement with the client, the payment terms, the number of other clients the business has, any entitlement to holidays, entitlement to maternity or paternity leave and pay, working hours, provision of own tools and so on.  There is no definitive list of what does and doesn’t constitute an IR35 business and all facts are taken into consideration.  The Revenue, as a starting point, might look at the contract you have with the end client but they will look at the surrounding facts as well.

If you are in any doubt about whether you fall within the IR35 rules or think you might be within the high risk category using the Revenue’s business entity tests, you should seek professional advice.

For further information in this regard, please contact

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