The Effect of 'IR35' on Limited Company Agency Temps

For information only

The 1999 Budget proposed measures to curb the use of intermediary service companies being used by individuals who would otherwise be deemed to be in employment were it not for the presence of the intermediary company. The Inland Revenue issued a press release explaining their proposals. This has since become universally referred to as IR35. The most widespread (but not the only) occurrence of the practice the proposals seek to prevent, is by 'contractors' employed within client organisations as temporary agency workers. In September 1999 the Inland Revenue published revised details of their proposals (see link below). These proposed regulations have become law and will take effect from April 6 2000 as The Social Security Contributions (Intermediaries) Regulations 2000, with regard to national insurance contributions (NIC), and as a schedule (enacted in 2000) to the Finance Act following the recent Budget, to cover the taxation elements. The regulations are broadly in line with the September 1999 proposals and are outlined below.

Traditionally employment agencies paid temps only for the hours they work. No sick pay, no holiday pay, no redundancy pay. As a consequence many agency workers opted to become self employed or operate via Limited companies. This meant they could be paid in gross, either directly or via the company. In both variants there were various tax and cash flow advantages over PAYE. This was also popular with agencies and clients due to the absence of a requirement to pay employers NIC on contracts set up in this way. Prior to 1988 the clear absence of an employment relationship between agency and worker (as opposed to worker and client) prevented the normal rules used to determine the employed /self employed distinction from applying. The presence of the agency also made it difficult to infer an employment relationship between client and worker.

The Income and Corporation Taxes Act 1988 (ICTA) closed this loophole. Section 134 (now replaced by s44 Income Tax (Earnings and Pensions Act 2003) set down that where a worker was in fact providing personal services to a client, and would otherwise be deemed to be an employee and assessed for tax under schedule E, the presence of an employment agency would not in itself change the position. More importantly the onus was/is on the employer to determine this and accept responsibility for the relevant deductions. In this respect, because they collect PAYE and NIC contributions under various employment agency laws, this is the agency. An individual worker is permitted to operate as self employed for one contract and PAYE for another, depending on the nature of the engagement.

The 1988 legislation did not however effect Limited company temps. In this scenario, the agency contracts with the Limited company, who in turn contract with their own members/directors/employees. The agency also contracts with the client. There is thus no direct legal relationship between the client and the Limited company or the client and the individual worker. Nevertheless in reality the situation was not very different from that of self employed agency temps. Like the self employed, the system is open to abuse as well as legitimate tax/NIC's avoidance. It is the growth in this method of work, particularly in the IT industry during the 1990's which has alerted the Inland Revenue once again to the issue.

The September 1999 proposals, and subsequent legislation, are more straightforward than those originally put forward in April. The revised proposals state that, in circumstances where an individual is providing personal services via an intermediary, and the individual would otherwise be deemed to have been in employment (and thus treated for income tax purposes as Schedule E, PAYE), but for the presence of the intermediary, the new rules will apply. Under the new rules the income from that particular work will be assessed under schedule E. This is subject itself to some small existing allowances under schedule E and a 5% allowance for the running of the intermediary service company. The test for what is deemed to be personal services is to be the same as that which is applied to self employment, where no intermediary service company exists. The intermediary in this context refers to a Limited company or a partnership and not the employment agency. The rules do not apply where the client is not in business himself (for example services provided to a householder who would not be expected to operate PAYE). Additionally, an individual who only receives remuneration which is subject to PAYE, will be unaffected.

In practice this means that individuals who are providing personal services and who are operating via Limited companies as agency temps will be required to treat most of that income as if it where PAYE. However there is one fundamental difference over the way Limited companies have been dealt with in comparison with the self employed. In the case of those paid as self employed, but were subsequently deemed to be providing personal services, the liability falls upon the employer to identify the correct nature of the engagement and operate PAYE. It is the nature of the engagement which determines the liability, and the employer who is liable where tax or NIC's are due.

However, in the case of intermediary service companies, under the new rules, it is the intermediary company who must determine the nature of the employment and not the client or, where an agency is involved, the agency. As with self employed individuals, it is perfectly acceptable for an individual to bill via his/her company for one contract and as an employee for another.

This is a more logical approach than earlier proposals, but is still radical in so far as it looks through the corporate structure, to the relationship between the individual officers, directors or members of a company and the client of that company. Nevertheless it leaves the company responsible for its own conduct. Had the Inland Revenue gone the extra step (as threatened in April) and made clients or agencies liable for determining the employed status of, what is in effect their suppliers staff, this would have had as grave a consequence in company law as in tax and employment law.

In practice for the agency worker operating via a Limited company the revised proposals have two effects. Firstly they mean that the presence of an agency or the intermediary itself will no longer mean that employment does not exist. Secondly, in most cases, it is the individual worker as director, officer or member of the intermediary company who must now determine if the special rules must be operated. To do this, one question must be determined. Is the individual providing personal services? If he/she is, then the new rules will apply. If he/she isn't, then it is permissible to bill via a company with impunity (as could a self employed worker bill in gross in the same circumstances). The important question is therefore what determines if personal services are being provided.

Plainly being registered as self employed is of no consequence (Under s134 ITC 1988). Being paid via a Limited company is also no longer of consequence (as a result of the new legislation - even though slightly different rules apply). The Inland Revenue have said that the same test will apply under the new rules as those already existing for the self employed.

These are not, as the Inland Revenue correctly point out, a simple question of law. Previous case law indicates that not only will each case be decided on its specific facts, but that employment can exist for the purposes of taxation but not for statutory benefits/protection and visa versa. Nevertheless the Inland Revenue provide a set of guidelines which it would obviously be unwise to ignore. The presence of all or some of these, may determine employment or self employment. The Inland Revenue state that a contract between the parties alone is not sufficient. An employed person cannot and a self employed person generally can provide other personnel to carry out the task, determine his/her own hours, not be bound by set hours or be obliged to be at a location determined by the client. Most importantly an employed person (i.e. someone providing personal services) is under the direct control of the client. Additionally a self employed person is paid for completing a task (not hourly or weekly), has a final say in how the business is run, risks his own money in the business, and is responsible for losses as well as profits.

These same rules now apply to individuals operating via Limited companies. Under the new rules the company must determine which category its staff member falls into. In the case of agency temps, they must also comply with the special rules as outlined in s134 ICTA 1988. (i.e. that where an agency is present and the worker is providing personal services, PAYE must be operated). This does not however assist the decision as to whether personal services are being provided.

If it is accepted that agency temps are by default providing personal services, then the argument for using Limited companies in this way becomes more or less academic. However that assumption is probably wrong. The Inland Revenue have stated that any agency contract under standard terms lasting for one month or more would 'normally be viewed ' as falling into the new rules. This however is nothing more than an opinion - it is not the law. The only precedent that agency workers are providing personal services comes from the apparent acceptance of this by agencies in refusing to continue making gross payments to the self employed when working in this capacity.

This is probably because agencies themselves were/are liable in circumstances where they often had no knowledge or control of the day to day relationship between the worker and client. Under the new rules, as it is the intermediary company itself that both determines and carries the liability for that relationship, it is therefore the company (and not the agency) that is in the best position to ensure that services provided fall within the rules.

The future of Limited company contracting via employment agencies (and directly) appears to rest on the answer to the 'personal services' question. Nothing in the rules prevents the practice from continuing. However individuals operating in this way will have to examine the benefits of doing so and take more responsibility for their own and the company's conduct. Because agencies will not be liable in the event that an individual is subsequently found to have been providing personal services, the agencies will be more willing to continue the practice of paying via Limited companies than they were following the ICTA in 1988.

Many Agency contractors operating via Limited companies will be caught by the rules. However the mere practice of working in this manner is not an indication that this is so. People who are likely to be affected by this should familiarise themselves in detail with the rules and either make provision for them when calculating tax/NICs liability, or arrange their affairs in such a way that it is clear they are not providing personal services and thus fall outside the new rules. For many, there is still a benefit to working in this way (given the 5% allowance, which is not subject to any qualification) and the independence operating in this way can bring, even where all the contracts entered into are caught by the new rules. However the onus lies fully on the individual and the intermediary company to make that decision.

We strongly advise anyone with an interest in this matter to look at the Inland Revenue's own comprehensive web site at;

And for an alternative view from the contracting industry at;

Please note: This is our interpretation of the Budget 99 proposals. It is not a definitive legal opinion. For more details of Inland Revenue information on IR35 follow the links above.