Is the HMRC business entity test just scaremongering?

This article comes courtesy of Meades Contractors LLP, a specialist contractor accountant. They've dipped into their considerable expertise and given us their opinion on a tax-related hot potato among contractors at the moment – the HMRC business entity test. Thanks for your valuable advice chaps!

As you’re probably well aware, HM Revenue & Customs (HMRC) has launched a business entity test on their website. Its 12 questions are basically a risk assessment designed to establish if a contractor falls under IR35 legislation.

What is IR35?

IR35 legislation was introduced on 6 April 2000. It was designed so the taxman could distinguish between ‘disguised employees’ and genuine contracting companies.

The government was concerned about companies hiring workers through their own service companies. Doing this avoided the tax obligations associated with having permanent employees, while simultaneously allowing contractors to exploit the financial advantages of working through a corporate structure (but for only one client).

There are a number of factors to consider when deciding whether a particular contract falls under IR35 legislation. They include, but are not limited to, what’s known as ‘The Holy Trinity’ case law:

• Control – is the company able to work under its own control or is its method of working dictated by the direct supervision and instruction of the contracted agency or end-user/client?
• Substitution – does the company’s contract mention a specific individual who must carry out the contract on behalf of the company (normally referred to as the ‘relevant consultant’) or does the company have the right and would actually be able to substitute individuals as it deems fit?
• Mutuality of obligation – does the company have to accept work offered by the agency, end-user or client or can it ‘pick and choose’ the work it wants to carry out? In addition, is the agency, end-user or client obliged to offer the company work?

What does the HMRC business entity test mean for the contractor?

Arguably, not much. Creating a generic IR35 test for contractors to complete in order to establish whether a contract falls foul of the legislation is not quite enough. The process requires a lot more preparation, thought and expertise than that.

Contractors need to have their personalised contract reviewed on a case by case basis by an IR35 specialist – preferably a firm of IPSE-accredited accountants.

Specialists are aware of ‘The Holy Trinity’ IR35 case law and can apply their expertise to each individual’s case. By encouraging contractors to complete the business entity test, HMRC are effectively creating the law, not enforcing the legislation – which is their main duty.

Why has the IR35 test come about now?

Put simply, IR35 legislation has not generated the revenue it was meant to. HMRC are under pressure from the government to keep enforcing it until it does.

The answers given to each test provide an indication as to how risky a contract might be in terms of an HMRC review, rather than being an accurate guide to the status of a contract under IR35.

Having now seen the 12 business entity tests it is very clear that, in our opinion, they’re designed solely to convince contractors that there’s a high risk their contracts are subject to IR35.

The result? More revenue for HMRC.

What's the potential impact for contractors?

The questions don’t reflect the true position of the case law established over time, giving conflicting messages to the contractor rather than educating them on what IR35 legislation is.

That means thousands of people could lose out on significant amounts of money by not assessing their contracts accurately.

Louise Williams, a partner at Meades Contractors LLP says: “I think HMRC is going to scare or even intimidate people into thinking that an IR35-friendly contract would actually fall foul of the legislation. Therefore this could influence the contractor into accounting for their contract using the IR35 legislation and potentially result in them losing significant sums of money.”

The problem is that there are numerous different ways to word clauses within contracts.  That’s why specialists have to review them on a case by case basis; and it’s also why generic questions fail.

For example: ask the same question of two different contractors, with identical contracts, and you could easily get two different answers. The test questions are subjective – contractor A may interpret them in a totally different way to contractor B.

The legislation IR35 specialists refer to is not subjective. It’s based on case law and precedence. It’s the only reference that really matters and it’s why you should always talk to a specialist if in doubt.

Image used under license from Shutterstock.