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HMRC’s IR35 business tests – what next for contractors?

The new HMRC IR35 guidance, which includes 12 ‘business entity tests’ to help taxpayers establish the risk they face of an IR35 investigation, has been universally criticised by industry experts. So, where should contractors go from here?

On May 9th 2012, HMRC published a lengthy PDF document which included a set of example IR35 scenarios, an overview of how HMRC determines ‘risk’, alongside the business test.

Low, Medium or High risk?

Answers to each of the 12 questions included in the test are assigned a score, and the total score for all the questions is used to work out the risk a participant theoretically faces of being selected for an IR35 review.

The trouble is, the vast majority of professional contractors would find it hard to score much more than 10 points (and therefore be at a ‘high’, or at best ‘medium’ risk of investigation) due to the way HMRC has weighted the answers.

For example, you score 2 points if you require PII insurance, and a mere 1 point for having a business plan and a business bank account.

However, if you have suffered a late paying client over the past 24 months, which has cost the equivalent of 10% of turnover or more, you get 10 points. As many commentators have pointed out, many business would have gone to the wall if they were unable to recover 10% of their turnover.

The most important answers, by far, are whether or not you employ other people who contribute at least 25% of turnover, and if you have actually sent in a substitute worker to take your place on a contract job. If you can answer yes to these questions, you score 35 and 20 points respectively – either providing enough ammunition to be deemed a ‘low’ risk immediately.

HMRC guidance widely criticised

Of course, as employment status experts keep pointing out, this guidance has not changed IR35 in any way at all. The tests do not establish whether or not you are even caught by IR35 or not, they merely show how HMRC would determine an individual’s risk to being investigated.

Unsurprisingly, most criticism of the new guidance has been aimed at the way the answers are scored, and most would agree that HMRC has completely failed in its aim to provide more certainty to contractors over IR35 issues.

One could argue that one positive to come out is that we now know the importance HMRC attaches to the different IR35 factors (e.g. the large number of points given for using a substitute, compared to a mere 2 points for having a Right of Substitution clause in your contract).

What contractors should do now

HMRC is thought to have assembled 36 specialist inspectors across three teams to oversee an increased efforts to enforce IR35 over a 12 month trial period.

Ricky Coleman from employment status experts Lawspeed told us:

“The usefulness of the ‘business entity test’ is limited and it is still advisable to seek expert advice on each separate assignment, regardless of the risk level given to the company as a whole.”

The general advice to contractors therefore remains the say; make sure that you use a professional IR35 contract review service for each new contract you take on, ensure that your working practices match the terms of your contract(s), and take out IR35 insurance to cover any costs of representation you would otherwise have to bear.

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