What is IR35?
IR35 sees medium and large private sector businesses in the UK become responsible for setting the tax status of any contract work they use from April 2021. It is designed to make clear the true nature of an employee, whether they are a genuine contractor or a disguised employee. Previously, the onus was on the contractor to determine their own status as an employee or contractor. But, with IR35 now in effect, the responsibility falls to the organisation.
Why is IR35 being introduced?
The Government initially introduced IR35 last year with the intention to implement it in April 2020. Given the COVID pandemic, they postponed the reforms of the off payroll working rules until now.
It was hoped that the Government would review the implementation of IR35 from the advice given by the House of Lords suggesting it would have a negative financial impact on the economy.
Some contractors and their clients try to take advantage of this situation by working as if self-employed when, in reality, they are employees. This legislation has been introduced to combat this tax avoidance by workers and organisations and seek to differentiate between contractors and those who could be employees, would their intermediary company not have been there.
Who does IR35 apply to?
The rules apply to all medium and large private sector businesses and all companies in the public sector. Businesses who closed as small for the tax year are exempt and, you can work this out if you fall within two or more of these requirements:
- A net turnover of less than £10.2 million
- A balance sheet total of less than £6.1 million
- Has less than 50 employees
What does inside vs outside IR35 mean?
Being inside IR35 means the worker is deemed as an employee for tax purposes so PAYE must be applied. Conversely, to be outside of IR35, a worker is considered a ‘genuine’ business and can be paid by their Personal Service Company (PSC) via a mix of salary and dividends.
If a contractor is considered inside IR35, they would need to treat all earnings as employment income. However, they would not automatically have a right to employment rights such as sick pay or annual leave, nor would they have any added job security.
Because of this, it is commonly felt that, for contractors, they want to fall outside of the new IR35 regulations.
What is a PSC?
Workers of Personal Service Companies (PSCs) are often referred to as contractors and their status is generally defined by being a company that mainly sells the services of an individual, or a small group of individuals. Plus, the individual(s) that provide the service are also owners/directors of the company.
There is no clear definition from HMRC which can often lead to ambiguity.
What implications does IR35 have for my business?
The 2021 changes to IR35 mean the responsibility for assessing IR35 status now falls to the private sector business engaging with contractors. Previously it was for each contractor who had that responsibility for accounting any tax and NIC due.
If HMRC decide a status has been incorrectly assessed, it is the businesses that will be held liable.
You are obligated to determine the IR35 status of each contractor worker your company engages with, regardless of the channels with which this happens (such as a recruitment agency). Take reasonable care when reaching a decision on a workers’ status – this provision came after blanket rulings in the public sector were applied to large groups of off payroll workers without due consideration. If reasonable care is proven to not have been taken, the organisation will be liable for penalties set by HMRC.
Behaviours which indicate reasonable care are:
- Accurately applying and keeping a record of the employment status principles
- Applying HMRC guidance on determining status
- Seeking the advice of a qualified, professional advisor
- Accurately completing HMRC’s Check Employment Status for Tax (CEST) tool
- Checking existing individual determinations to ensure they remain valid / accurate and reviewing processes where necessary
What do I need to do if IR35 applies to me?
As a contractor, if IR35 applies to you, then you will need to calculate the ‘deemed payment’ on your limited company income which extends to income tax and National Insurance contributions.
You can use HMRC’s Check Employment Status for Tax tool which is free to use but has come under criticism for its simplistic interpretation of legislation, plus the checklist approach and over-reliance on the substitution test.
As an organisation, you need to:
- Assess the IR35 status of your contractors – see the section below for the criteria.
- Provide a ‘status determination statement’ for each worker as to if you believe that IR35 applies to them or not. You must include your reasoning
- Apply the relevant payments such as PAYE and deduction of tax and NI
- Provide a disagreement process, where necessary, within 45 days including reasoning.
How IR35 status is determined?
There are 10 principles used to determine employment status and these are known as ‘tests of employment.’ The first three here – control, substitution and mutuality of obligation – are recognised to be the most important factors.
1. Control – what degree of control does the business have over what, how, when and where the worker completes the work?
2. Substitution – Is personal service by the worker required, or can the worker send a substitute in their place?
3. Mutuality of obligation – This is a concept where the employer is obliged to offer work and the worker is obligated to accept it.
Other principles:
- Provision of equipment
- Financial risk
- Basis of payment
- Part and parcel
- Exclusive service
- Intention of parties
- In business on your own account
For more useful IR35 tips, visit our blog here