As of April 2015 the business entity tests are no longer being used. HMRC has, however, given a commitment not to investigate any contractor who took the test and got a low-risk score, for three years.
One way of checking your IR35 status as a contractor is to take HMRC’s online business entity test. This assesses both your IR35 risk and your chances of being investigated. Brought in in 2012, the test is based on twelve questions online which contractors working through limited companies can work through. Each of these twelve questions has a set weighting and depending how they answer the questions and the score they receive, contractors will be able to see what level of risk they are. The risk categories are divided into low, medium and high.
HMRC has designed the test with the aim of screening limited company contractors and being able to then focus most of its attention onto the high-risk band contractors. They are the ones most likely to have compliance issues and be within IR35 so it makes sense for HMRC to check them first. Lower risk contractors who can provide proof to back up their low scores on the test will be less likely to have to go through any kind of HMRC status enquiry and will not need to be investigated for another 3 years.
On the other hand, anyone in the medium or high-risk categories is likely to feel the full force of an IR35 status enquiry. As any contractor knows, this can lead to having to pay back taxes and NIC’s, interest and penalty payments as well as losing expenses.
How It Works – The IR35 Business Entity Test Process
The business entity test process begins with HMRC asking the contractor if they have thought about IR35 and if they consider themselves to be outside of the IR35 legislation. If so, they go on, can the contractor provide evidence to support their responses. At that point, any contractors who are able to provide that evidence and prove that they aren’t in false employment – and can show they are part of a genuine independent contracting business – will have their IR35 status enquiry halted straight away and will not be required to do it again for at least 3 years.
Once completed, a business entity score is something a contractor can use to help demonstrate that they are definitely ‘in business’. Nevertheless, it is still important for contractors to make sure they keep using best IR35 practice at all times.
How It Works – The IR35 Business Entity Questions
For your reference we have listed the twelve questions (and their weighting) which make up the HMRC business entity test:
- Does your business rent or own business premises which are separate both from your home and from the end client’s premises? (Yes = 10 points)
- Do you as a contractor need Professional Indemnity Insurance? (Yes = 2 points)
- Efficiency – Have you, as a contractor, in the past 2 years, received full payment for any work which you completed ahead of schedule? (Yes = 10 points).
- Assistance – Does your contracting business use any other workers – who contribute 25% or more towards your turnover? (Yes = 35 points).
- Advertising – Have you spent in excess of £1,200 on advertising in the past year? (Yes = 2 points).
- Previous PAYE – Have you been previously employed by your current client, on a PAYE basis? (Yes = take off 15 points).
- Business Plan – Does your contracting business have a business plan, and does it have a business bank account? (Yes = 1 point).
- Repair at Own Expense – Would your business be required to pay to fix any mistakes you have made at work? (Yes = 4 points).
- Client Risk – Have you been unable to recover any payments for a client at any time in the past 24 months that were worth at least 10% of your business’ annual turnover? (Yes = 10 points).
- Billing – Do you invoice clients before being paid, and do you negotiate your own payment terms? (Yes = 2 points).
- Substitution – Are you allowed to provide a substitute if you are unable to perform your contract duties? (Yes = 2 points).
- Actual Substitution – Have you actually had to use a substitute over the past two years, and have you been responsible for supervising and paying the substitute? (Yes = 20 points).
High Risk = 0 – 10 points
Medium Risk = 11 – 20 points
Low Risk = 21 points and above.
With the score ranges above, it is clear that a high number of contractors will find themselves in the high and medium risk bands, despite their best intentions.
Remember, It’s Not Just About The Business Entity Test!
However, contractors should always remember that these business entity tests are simply a kind of screening process and are there to help the Treasury focus its compliance investigations in a better way. The legislation behind the tests is still the same as it always was. If a contractor was to find themselves being investigated all that would matter would be whether they were within the accepted limits of that legislation and that the case law on IR35 was on their side. Everything else, including the business entity test, would be irrelevant.
Supposedly the business entity test and the IR35 forum were there to provide a better-administered version of IR35 but in reality, the risk scenarios and business entity test brought in by HMRC merely added, even more, confusion for contractors trying to make sense of it all. Thanks to the business entity test, more and more contractors will have to take part in unnecessary, expensive and probably stressful IR35 enquiries.