In May 2012, HMRC published Intermediaries Legislation (IR35): business entity tests, example scenarios (www.hmrc.gov.uk/ir35/guidance.pdf).
The business entity tests give small limited companies guidelines about the probability that a limited company is 'inside IR35' (www.hmrc.gov.uk/ir35/). A set of 12 tests gives points to a limited company. A limited company that has many points is less likely to be 'inside IR35' than a limited company that has only a small number of points.
Business entity test 9 is the client risk test. The client risk test is defective, because a careful limited company is less likely to pass the test than a careless limited company. The careless limited company loses money and gets points, but the careful limited company does not lose money and does not get points.
The client risk test is shown below.
"Has your business been unable to recover payment:
- for work done in the last 24 months
- more than 10% of yearly turnover?"
A careful limited company can decrease its risk by using methods such as these:
- Make the customer pay before doing the work.
- Use invoice factoring.
- Do not sell to a possible customer.
- Invoice frequently and do not supply more goods or services until the previous invoice is paid.
I asked HMRC about this problem. The response from HMRC is not satisfactory:
"I believe you may have misunderstood the Client Risk Test. It is not intended to disadvantage well run companies but is a risk that a company may experience."
(Note. Mike Unwalla operates TechScribe as a sole trader. Therefore, IR35 does not apply to TechScribe.)