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IR35 Business Entity Tests

HMRC has started the process of overhauling its operation of the IR35 regime for personal services companies with new guidance issued in May 2012 that sets out basic risk factors which they say will potentially increase a contractor's chance of being investigated.

This overhaul is clearly designed to facilitate an increase in IR35 investigations.  As expected following leaks last month, the 12 business entity tests set out in HMRC's 47-page intermediaries legislation guidance notes are illustrated by six example scenarios.  HMRC said the tests are designed to build up a picture of how a contractor's business works and how they provide their services.  The tests include the following:

• Business premises test - Does the business utilise business premises separately from the contractor's home or end client's premises?
• PII test - Does the contractor need professional indemnity insurance?
• Efficiency test - Has the business had the opportunity in the past two years to increase its revenue by working more efficiently?
• Assistance test - Does the business employ any workers who bring in at least 25% of annual turnover?
• Advertising test - Has the business spent over £1,200 on advertising in the past year; entertainment does not count as advertising?
• Previous PAYE test - Has the end client engaged the Director during the previous 12 months with no obvious changes in the working arrangements?
• Business plan test - Does the company have a business plan with a regularly updated cash flow forecast, and does it have a separate bank account?
• Repair at own expense test - Does the business have to bear the cost of rectifying any mistakes?
• Client risk test - During the past two years, has the business been unable to recover payment amounting to more than 10% of yearly turnover.
• Billing test - Does the business invoice for work carried out before being paid and negotiate its payment terms?
• Right of substitution test - Does the business have the right to send a substitute?
• Actual substitution test - Has the business hired anyone in the previous two years to do the work it has taken on?

The HMRC guide explains that the tests are not set in stone, and are an extension of the risk-based approach it extends to all of its investigations.

The business entity tests are something against which you should be able to self-assess to see how you scored by their internal rating.  But HMRC aren't revealing what the detailed risk criteria are because of the fear people might arrange their affairs accordingly.

In any event the business entity tests are just a diagnostic tool.  The actual application of IR35 will always come down to employment status factors that must be tested against case law going back over 40 years and will always take into account contractual terms.

HMRC is apparently seeking to appoint specialist IR35 teams at offices in 3 areas of the UK to pilot the new diagnostics. Anyone with concerns about the tests and the risk of investigation can contact us.

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