However, there could be a case that they can now provide a previously non-existent route to demonstrate that you are 'In Business on Your Own Account' and therefore outside IR35. Legal expert on contractor issues, Roger Sinclair, takes a closer look at the underlying intent of the business entity tests:
Business Entity Tests
This is actually where it gets exciting – there are real opportunities here. If you read this section of the guidance as simply rehearsing the IR35 tests and their relative importance in a different way, you really don’t get it! It’s not doing that at all.
There are 12 points. To each is allocated a score. To take the test you answer each point and add up the score. If the total is 20+ you are considered ‘low risk’. If 10-19, ‘medium risk’; and if less than 10, ‘high risk’.
It’s important to understand what is meant by ‘risk’ here. ‘Risk’ is subjective, and on the part of HMRC. It’s not your risk, it’s theirs. It means what they – without looking at your contracts or your working arrangements - see as the risk that you might fall within IR35.
It’s perfectly possible that you might have a low score and be perceived by HMRC as ‘high risk’, and yet be very clearly outside the scope of IR35. It’s not a measure of your risk of being inside IR35, that depends on many factors, several of which are not included in these 12 points (and I would say that even in the case of those that are included inappropriate weighting has been given if the results were to be used for the purpose of assessing actual IR35 status). Nothing has changed which might increase the risks of falling inside IR35. What has changed is that, for those who qualify by scoring 20+ points on the HMRC Business Entity test, there is now a clear and separate route to stay outside IR35.
I’ll summarise the points here (though I stress this is a summary, you do need to read the full wording in the guidance in respect of each point, each has its own relevant detail). In summary, the points are:
1. Business Premises - Whether you or your business owns or rents premises separate from your home and the client’s premises (10 points)
2. PII - Whether you need PI insurance (2 points)
3. Efficiency - Whether in the past 24 months you have had the opportunity to increase your business income by working more efficiently (10 points)
4. Assistance - whether you engage any workers (not directors/shareholders) who bring in at least 25 per cent of yearly turnover (35 points)
5. Advertising – whether you spent >£1200 on advertising in the last 12 months (2 points)
6. Previous PAYE – if you had worked for the current end client on PAYE with no major changes to working arrangements during the period of 12 months immediately prior to 31st March last (minus 15 points)
7. Business Plan – whether or not you maintain a business plan and cashflow forecast, and have a separate business bank account (2 points)
8. Repair at own expense – whether you would have to bear the cost of putting right mistakes (4 points)
9. Client risk – bad debts of 10 per cent of yearly turnover within the past 24 months (10 points)
10. Billing – do you invoice and negotiate payment terms? (2 points)
11. Right of substitution – do you have the right to substitute? (2 points)
12. Actual substitution – have you actually substituted during the last 24 months? (20 points)
On page 10 of the guidance (and repeated on page 14), HMRC say (emphasis added):
"If you prove to our satisfaction that you are outside IR35 or in the ‘low risk’ band, then we will close our IR35 review. And we will undertake not to check again whether IR35 applies to you for the next three years, provided that:
- the information you have given us is accurate
- your circumstances – and, in particular, your working arrangements – do not change in that time."
So, as I read it, what that says is, ‘if we start asking you about IR35, if you can show a score of 20 or more on the Business Entity Tests, then you can tell us to go away; we will accept that, for that reason alone, regardless of the contracts and the reality of your engagements, we will accept that for that reason alone, you are outside IR35; and so we will go away, and will not bother you again for another three years".
What these points in the Business Entity Tests are trying to establish is not whether or not you are outside IR35, it’s whether or not you can be accepted by HMRC as being IBOYOA – In Business On Your Own Account. Where the guidance refers to ‘risk’, think of it as ‘High/Medium/Low Risk … of NOT being clearly IBOYOA’ – and if you are not IBOYOA then you must make your own assessment (against the usual criteria) of the risks of being inside IR35.
The Business Entity Tests offer a way of filtering out those who will (on the basis of the above 12 points, weighted as HMRC have chosen) be clearly accepted by HMRC as being ‘IBOYOA’ – and those who score 20+ points against those criteria will be treated as outside IR35, without any requirement to consider either the contract, or the working arrangements.
And that, to my mind, makes sense. If you are indeed IBOYOA, then you might think that IR35 should not apply to you – and that your situation is one that was never (ever) intended to be caught by IR35. The hypothetical contract between you (the individual) and the client would not be one of employment, it would simply be a contract between one genuine business and another.
Finally, we see some acknowledgement of this principle by HMRC, a willingness to actually take it into consideration, and a basis for structuring how they will do so that is sufficiently transparent for you as the contractor to assess how you stand in a way that is reasonably clear and objective.
I predict that there will now be considerable efforts shown by many contractors to bring themselves into that magic 20+ zone – and to keep themselves in it. Because HMRC now appear to accept that those who can do that are indeed IBOYOA, and so far as IR35 is concerned, you can quite legitimately tell HMRC to leave them alone!
Reproduced with permission of Roger Sinclair of Egos. Roger is a legal specialist for IT contractors with a wealth of experience on IR35 and status issues. He is also a member of Shout99's panel of experts, as "egos".
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Susie Hughes © Shout99 2012