Tax Law Rewrite may widen IR35 scope
It appears that the Revenue may have taken advantage of the Tax Law re-write to increase the scope of IR35.
As part of the general Tax Law Rewrite Project the Income Tax (Earnings and Pensions) Act 2003, which has received the Royal Assent and comes into effect from April 2003, will replace those chapters of the Income and Corporation Taxes Act 1988 and some parts of subsequent Finance Acts, which deal with taxation under Schedule E.
It appears that the Revenue may have taken advantage of the re-write to make a small change to the scope of IR35. Currently the income tax aspects of IR35, which are set out in Schedule 12 to the FA2000, apply to a worker who would be "regarded for income tax purposes as an employee of the client".
However, in the parallel legislation that deals with the National Insurance aspects of IR35 – SI 2000 No. 727
The Social Security Contributions (Intermediaries) Regulations 2000 – IR35 applies to situations where the worker "would have been classified as an employed earner".
An "employed earner" is defined in legislation as someone who works under a contract of service, or someone who is a "holder of an office" – typically a director.
Hence it is possible in certain situations for someone to be subject to the NI elements of IR35 but not the PAYE aspects. In their Employment Status Manuals – section ESM 3268 - the Revenue cite a situation where a non-executive director is not subject to IR35 for income tax purposes in respect of fees earned as a non-executive director, because he is not an "employee" but is liable to NIC on those fees because he is an employed earner.
However, under the revised legislation, the definition of employee states that "The provisions of the employment income Parts that are expressed to apply to employments apply equally to offices" (section 5) and that in relation to offices "employee means office holder".
Some commentators are viewing this as indicating that the scope of IR35 has been widened to include office holder's income within the scope of IR35. However, to make sure I have asked the Revenue to confirm whether they view the Income Tax (Earnings and Pensions) Act 2003 as changing the scope of the PAYE aspects of IR35 in any way.
Impact?
If this does represent a substantive change what is its impact? For most freelancers the impact is probably minimal. However, for those freelancers who are interim managers and who may have built up a number of non-executive directorships there might be some new issues to consider if the change is confirmed as bringing their directors' fees within the scope of PAYE as well as NIC under IR35.