There is no getting away from IR35 and it's important for contractors to understand the ins and outs of what the rules cover and when they will take effect. Here's a run-down of some of the main points, with some examples of how it will affect contractors in certain circumstances. Easy-fix solutions For the majority of contractors there are clearly no easy ways around IR35. Having your spouse set up as a company or using an offshore company will have no effect. Similarly, you will be caught by IR35 if you work abroad unless you cease to be a UK resident in the process. There is one group of contractors who may be able to side-step IR35. Those contractors who have a partner but are not married may well be able to take employment from a company owned entirely by their partner. They may receive a salary of, say, £30,000 per annum and their partner might draw dividends or retain profits within the company. The Inland Revenue is aware of this problem which exists because, unlike a spouse, a partner is not a connected person. It remains to be seen whether or not the definition of connected person will be changed in the Budget. Retained profits at 5 April 2000 There will be no changes to what a contractor may do with retained profits. A contractor may therefore continue paying dividends or hold such profits long-term as an investment. Application of IR35 IR35 will apply to income from relevant contracts only. Income such as bank interest or occasional consultancy income will not be caught. IR35 will be applied to money received in a tax year. Therefore, if payment for work done in March 2001 is received on 6 April 2001 it will be used to calculate remuneration for the year to 5 April 2002, not 5 April 2001. Furthermore, monies received, say, on 6 April 2000 for work done in March 2000 will be exempt. Special concessions for training There will be no special concessions for training or, for that matter, any other expenses. Only pension contributions and Schedule E expenses such as contract-related travelling expenses may be deducted before calculating remuneration. The Inland Revenue has, however, confirmed that training costs may be paid by a client or agent. Company cars A certain amount of confusion seems to exist in the area of company cars. Very often the tax value of a car benefit is higher than the running expenses of a car. It is not unusual for an employee to be taxed on a benefit of £7,000 while their employer is only entitled to tax relief on expenses of £4,000. The Revenue has said that the rules will ensure there is no double tax and National Insurance charge brought about by the existence of a company car. The easiest way to achieve this would be to allow as a deduction in calculating remuneration the value of the benefit in kind. This is fine except where a company's turnover is made up of income from both relevant and non-relevant contracts. Such cases may present practical problems and contractors with mixed income who have company cars may have to keep separate mileage records for each contract. The five per cent rule and Corporation Tax It is clear from Sarah Walker's answers in the interview that there is no five per cent rule. Instead, there is a 95 per cent rule. Ninety-five per cent of income received from relevant contracts in a tax year must be accounted for as salary, employers' National Insurance, Schedule E expenses and pension contributions. There is no restriction placed on expenses and Corporation Tax rules will apply to contractors in the same way that they apply to all other companies. Eventually this will mean that expenses in excess of five per cent of turnover will not attract tax relief, but this may be three or four years away. Take, for example, a contractor whose next year end is 30 September 2000. They have no problem relieving expenses in that year because they will have paid little remuneration between 1 October 1999 and 5 April 2000. They are therefore likely to have a high profit in that year. In the year to 30 September 2001 they may draw excessive remuneration which, together with expenses, creates a tax loss. That tax loss can then be carried back and set against profits for the year to 30 September 2000 resulting in a tax rebate. In the first half of the year to 30 September 2002 the contractor may find that remuneration only needs to be low because excessive remuneration was paid in the period 6 April 2001 to 30 September 2001. As a result, expenses in excess of five per cent of turnover should be capable of being relieved in the year to 2002 and it won't be until the year to 30 September 2003 that the five per cent limit bites. Even then that limit will increase if the company has any other income such as bank interest. The Inland Revenue has now issued draft guidance to help contractors determine whether or not IR35 will apply to a particular contract. Meetings are taking place to fine-tune this guidance to try to achieve clarity. In the first issue of Computer Contractor next year I shall do my best to help navigate contractors through this complex maze. WEB LINKS - HM Treasury, www.hm-treasury.gov.uk/ - Tim Warr's Web site, www.warr.co.uk.
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