What is IR35?
Off-payroll working rules (often known as IR35) was introduced to address a form of perceived tax avoidance where individuals could seek to avoid paying employee income tax and national insurance contributions (NICs) by providing their services to clients through an intermediary, such as a personal service company (PSC).
To increase compliance with IR35 from 6 April 2020, all medium and large private sector businesses which engage individuals through intermediaries will be responsible for determining if the individual should be considered an ‘employee’ for tax purposes. If an individual is an ‘employee’ for tax purposes the company will be responsible for income tax and NICs. This brings the private sector in line with the public sector which has been subject to these IR35 determination rules since April 2017. It was estimated by HMRC that the public sector reform raised £550 million in income tax and NICs in the first year.
How we can help
We advise small, medium and large private and public bodies on all aspects of IR35 compliance, including;
- Assessment of current contractor arrangements and the applicability of IR35;
- Implementing and or reviewing policies and procedures for IR35 and how to make IR35 determinations;
- Dealing with challenges to IR35 determinations; and
- Contracts, including reviewing current arrangements and drafting new bespoke agreements.
Who will be affected by the April 2020 IR35 reforms?
Medium and large private sector clients will be affected by the changes to IR35. It is important to note that the changes will not apply to clients which are small businesses. The precise test will be set once the Finance Bill 2019 has been finalised and passed as an Act. Essentially, the current proposal is that a business will be exempt if two or more of the following criteria are satisfied:
- Its annual turnover is not more than £10.2 million;
- Its balance sheet total is not more than £5.1 million; and / or
- It’s number of employees is not more than 50.
There are other rules for determining when non-corporate entities are small.
When does IR35 determination requirements apply?
In simple terms, IR35 will apply when two elements are satisfied:
- the managed service company rules do not apply; and
- a contractor is considered an ‘employee’ for tax purposes.
The rules essentially seek to ensure that two individuals working in the same or similar ways will pay the same or very similar income tax and NICs, even if one is engaged via an intermediary.
In respect of the first element, the managed service company rules are only engaged where such managed service company (the intermediary) is managed by a scheme provider and the relevant individual does not exercise control over such company.
In relation to the second element, there are several factors which indicate whether there is an employment relationship (rather than a consultant or self-employed relationship). In summary, IR35 includes the application of four main principles to determine an individual’s employment status:
- Control: What degree of control the client has over the individual (e.g. what, how, when and where they work);
- Substitution: If there is a personal service requirement or if a substitute can be sent;
- Financial risk: What degree of financial risk there is for the individual (e.g. if fees are contingent on a particular outcome); and
- Mutuality of obligation: If there is an obligation to provide work and for it to be accepted. There are several other factors which would also need to be considered including benefits, integration with the client, provision of equipment and the contract type.
What is the effect of IR35?
The requirements from April 2020 include:
- making a determination of an individual’s status for tax purposes;
- communicating the determination; and
- making deductions for income tax and NIC and paying any employer NICs.
Businesses will need to make the status determination and communicate it by the time the contract starts or before any services are provided.
Importantly, if a business fails to undertake a determination or provide reasons in the timescales, the liability for income tax and NICs will transfer to that business until the determination is completed or the reasons are given.
What can be done to prepare for the IR35 April 2020 reforms?
In its consultation document, HMRC issued a warning to businesses not to delay in preparing for changes to the IR35 rules. The draft Finance Bill was issued in July which will ensure the reforms are implemented from April next year.
Businesses should therefore start taking steps now to prepare, including:
- assessing what use is made of contractors and if they are engaged through intermediaries;
- assessing if IR35 will apply and when relevant considering whether the small company exemption applies;
- reviewing any current contracts and considering the tax status of individual contractors’ from April 2020;
- deciding what approach will be taken regarding contractors caught by the IR35 rules (e.g. whether the client will absorb this additional cost or share the burden with the PSC via the renegotiation of fees);
- considering if a 5% allowance currently available would apply for the off-payroll working rules to reflect the costs of administering them. This could be available because responsibility is shifting from intermediaries to the business. This allowance will be removed for those engagements with medium and large-sized organisations. It will continue to be available for engagements with small organisations;
- reviewing internal systems, such as payroll software, process maps, HR and any existing on-boarding policies to see if any changes need to be made;
- implementing suitable policies and joined-up processes to ensure engagement or on-boarding of new contractors includes an appropriate IR35 assessment prior to engagement (it is important to show evidence of a clear assessment process);
- ensuring that different departments communicate and assess roles from a procurement, HR, tax and line management perspective for consistent decisions about the employment status of the individuals that are engaged;
- ensuring new contracts are appropriately drafted to reflect IR35 requirements and to include appropriate IR35 indemnities;
- identifying a legal adviser who can advise on IR35, support with reviewing contracts, drafting and the preparation exercise generally; and
- making provision to process income tax and NICs (including employer NICs) through PAYE if IR35 is engaged.
IR35 the questions being asked …
The off-payroll working rules, more commonly known as the IR35 rules, were designed to address tax avoidance whereby individuals would seek to avoid paying income tax and national insurance contributions (NICs) by performing their services through an intermediary.
The reform does not introduce a new tax or rules. The changes requiring medium and large private sector businesses to make an off-payroll working tax determination will apply from 6 April 2020. It is therefore vital that businesses start preparing now.
HMRC originally introduced IR35, also known as the off-payroll working rules, in 2000 to address the concern of ‘disguised employment’, i.e. individuals performing services through an intermediary such as limited companies and partnership to benefit from the tax advantages. They require that individuals who work like employees, but through their own company, pay similar taxes to other employees.
The reform will not stop anyone working through a company if that suits them. The reforms require a determination for tax purposes to be undertaken to seek to ensure that individuals that work like employees, but through their own company, pay similar taxes to other employees. Where the rules are engaged the organisation, agency, or other third party paying the individual’s company will need to deduct income tax and employee NICs and pay employer NICs.
Contractors are usually self-employed workers who provide services to clients for a set period through an intermediary, such as a limited company. Contractors have flexibility with regards to how they perform the services for the client. Contractors are not employees and are therefore responsible for arranging payment of their National Insurance Contributions (NICs) and income tax. From April 2020, the reforms will place an obligation on medium and large private sector businesses to determine if contractors are ‘contractors’ or ‘employees’ for tax purposes and to make income tax and NIC payments via PAYE if IR35 is engaged.
IR35 was first introduced in 2000 and already applies. The reform does not introduce a new tax or rules. The changes requiring medium and large private sector businesses to make an off-payroll working tax determination are set to take effect on 6 April 2020. The draft Finance Bill 2019 was issued in July which looks likely to ensure the reforms are implemented in April next year. The determination rules already apply to public sector bodies having being introduced in 2017.
HMRC has developed a calculator to check employment status for tax (CEST). This can be a useful tool but will not always be definitive, there are various additional factors which the Courts may take into consideration when determining the actual arrangements in place. Work is being undertaken to improve the calculator and if any output of the calculator is relied upon, it needs to be remembered that HMRC can still look behind the assessment to consider if the results reflect the reality of the engagement.
From 6 April 2020, the IR35 rules will begin to apply to medium and large businesses in the private sector. The reform will bring all sectors in line with the public sector, where compliance has improved since the reform was introduced in 2017.
From April 2020, the IR35 Regulations will place an obligation on private sector businesses to determine the tax status for contractors engaged via intermediaries and if the rules are engaged the organisation, agency, or other third party paying the individuals’ company will need to deduct income tax and employee NICs and pay employer NICs.
If the IR35 rules apply to your business, you will need to ensure that appropriate determinations are undertaken of the tax status of individual contractors engaged via an intermediary. You may also wish to consider implementing new policies and procedures which would build in an ‘IR35 assessment’ when onboarding any new contractors. Where a determination is made that the rules do apply, the organisation, agency, or other third party paying the individual’s company will need to deduct income tax and employee NICs and pay employer NICs.
IR35 is a set or tax rules first introduced in 2000 which is used to refer to tax rules designed to reduce tax avoidance by contractors who are deemed to be “disguised employees” (individuals carrying out similar work to employees but that charge for their services via a limited company or other intermediary. IR35 takes its name from the original press release announcing its creation published by the then Inland Revenue (now HMRC).
HMRC’s IR35 investigations have reduced over the years, however HMRC is likely to pay more attention to private sector organisations from April 2020, given the shift in the obligation to make determinations regarding the applicability of the IR35 rules.
Umbrella companies, and the workers performing services under such arrangement, can be affected by the IR35 rules. An umbrella company is an arrangement under which an individual is an employee of a company through which it performs services for a client. The worker will usually source the work themselves for which the umbrella company invoices the client. The umbrella company manages payment to the worker and its tax obligations in return for a fee payable by the worker.
The is no exemption for charities who will need to consider if the rules apply of if they are exempt under the small companies’ exemption.
Whilst the contractor in the Dragonfly Consultancy Ltd case was ordered to pay £99,000 to reflect the accrual of taxes, there is no hard and fast rule on backdated payments. The calculation of taxes payable is likely to be determined on a case by case basis. However, the reform itself is not retrospective. The current guidance is (and as was the case in the public sector implementation) that the HMRC will focus on ensuring businesses comply with the reform for new engagements, rather than focusing on historic cases. HMRC will not carry out targeted campaigns into previous years when individuals start paying employment taxes under IR35 for the first time. Organisations ’decisions about whether workers are within the rules will not automatically trigger an enquiry into earlier years.
IR35 should not be avoided and an appropriate determination of the factual position should be undertaken. HMRC and the Courts pay more attention to the actual working arrangements of contractors rather than solely relying on the terms of a contract. Whilst it is important to incorporate contractual terms that indicate a relationship falling outside of IR35 and the parties intentions, the contract should reflect what will happen in practice and a proper assessment of the tax status made accordingly. Using the check employment status for tax (CEST) calculator available from HMRC may help to identify if IR35 applies or not. Although CEST should be used with caution as the courts have used other factors when determining whether an arrangement falls within or outside the scope of IR35.
If a business fails to undertake a determination when required, the liability for income tax and NICs will transfer until the determination is completed. There is also risk of HMRC investigation, penalties and legal proceedings for non-compliance.