Tax for Contractors - Is the Pendulum Swinging?

The guidance relating to the tax legislation that HM Revenue and Customs (HMRC) use to determine whether a contractor who uses a limited company to carry out contracts should be treated as employed by the end-user client is contained in HMRC leaflet IR35.

The legislation is very important for contractors. If the tax treatment set out in IR35 is avoided, most remuneration can normally be taken by way of dividends, which avoids the payment of employer’s and employee’s National Insurance Contributions and also gives a considerable cash-flow benefit in terms of the time between receiving cash and having to pay tax on it.

When the IR35 legislation is successfully applied by HMRC, the ‘tax take’ rises sharply. Needless to say, there have been many tax cases regarding its application and, until fairly recently, HMRC have won the majority of them. However, a recent case, in which the ruling turned on mutuality of obligation, represents a considerable setback for HMRC and will be a relief for contractors with appropriate contractual arrangements.

Mutuality of obligation refers to the obligation that each party to the contract has towards the other and, in essence, is determined by whether the end-user client seeks to employ the person or just contract with an organisation to get the job done. It is determined by a long list of circumstances and is decided on the facts in each case.

In the case in point, which involved an engineer who contracted with Airbus through the medium of a limited company, the Tribunal decided that there was, as a matter of fact, insufficient mutuality of obligation for the engineer to be deemed to be an employee of the aircraft manufacturer for tax purposes.

Key aspects of the arrangements were that the contract was terminable without notice and that in the event of an IT system failure, the contractors left the premises whilst the employed staff had to remain.

Click here for further guidance on the difference between being an employee and being self-employed for tax purposes.