What is IR35?
Off-payroll working rules (commonly known as the IR35 rules) were introduced to address a form of perceived tax avoidance (i.e. where individuals may be avoiding paying employee income tax and national insurance contributions (“NICs”) by providing their services to businesses through an intermediary. An intermediary in these circumstances is usually a personal service company (“PSC”).
HMRC is seeking to address the issue of ‘disguised employment’ where individuals may perform services through a personal service company to benefit from tax advantages
What is a personal service company?
A personal service company is usually a company where there is only one employee, and the personal service company’s purpose is to supply that individual’s services to a business.
This article assumes that the business pays the personal service company for the individual’s services and that there are no other entities in the chain. Where there is a longer chain (e.g. where there is an agency involved), the position becomes slightly more complicated, and we will be issuing a standalone article on this point in the near future.
What is the impact of IR35?
Simply put, a status determination of the individual must be made, and the relevant tax must be paid.
Currently, if a private sector business engages an individual through a personal service company, then the responsibility to determine whether IR35 applies (i.e. whether there is an employment relationship) and to pay any employee income tax and NICs sits with the personal service company.
From 6 April 2020, all medium and large private sector businesses which engage individuals through personal service companies will be responsible for determining if the individual should be considered an employee for tax purposes (If so, IR35 will apply). Where IR35 applies, the business paying the PSC will need to deduct and pay income tax and NICs to HMRC.
Does IR35 apply to your business?
The IR35 rules will apply where there would have been an employment relationship between your business and the Individual if the individual had contracted directly with your business, rather than through a personal service company.
To put another way, IR35 will apply to your business if the individual, but for such personal service company, would be considered an employee. Whether or not IR35 applies will also depend on the size of your business.
Are there any exemptions to IR35?
HMRC has confirmed that small businesses will be exempt from the new IR35 rules. The exemption is still being finalised. However, your business is likely to be exempt if two or more of the following criteria are met:
- an annual turnover of £10.2 million or less;
- a balance sheet total of £5.1 million or less; and/or
- 50 employees or fewer.
Therefore, if an individual provides services to a small business in the private sector, the PSC will remain responsible for determining the individual’s employment status and if the IR35 rules apply.
What is the risk for your business if IR35 applies?
If a business fails to undertake a determination when required, the responsibility for income tax and NICs will transfer to that business until the determination is completed. There is also a risk of an HMRC investigation, penalties and legal proceedings for non-compliance.
When will the individual be considered to be an employee?
There are several factors to consider when deciding if an individual is an employee for the purposes of IR35, including whether:
- the business controls what the individual does, how they do it and when they do it;
- the business is under an obligation to provide the individual with work, and the individual is under an obligation to accept the work;
- the length of the engagement is open-ended and not for a specific task;
- the business provides the individual with all of the equipment/facilities to carry out their work;
- the individual receives benefits such as a pension, bonus, private medical insurance, company sick pay etc.;
- the individual is required to provide their services personally (i.e. a substitute cannot perform the services if the individual is unable to do so);
- the individual cannot accept work from other clients without permission;
- the individual is paid even if there is not sufficient work to keep them fully occupied (as per the position of an employee) and the individual assumes no financial risk in working for the business;
- the individual is integrated into the business (e.g. they have line management responsibilities, their name appears on the internal telephone directory, they have a company email address, they wear a uniform etc.).
If the above bullet points apply, then it is likely that there is an employment relationship between the business and the individual. However, it is essential to note that not of all of the above factors need to be applicable for an employment relationship to arise.
Why is it important that the terms of the contract in respect of the IR35 factors are reflected in practice?
It is clear from HMRC guidance that the terms of the contract entered into between the business and a PSC do play a part in determining the nature of the relationship between a company and the individual consultant. However, this will have little bearing if, in practice, the reality of the relationship does not reflect the terms of this written contract. The terms of the contract may bear all the hallmarks of a genuine consultancy relationship but, if this is not reflected in practice, the arrangement may well still be deemed “in-scope” for IR35 purposes.
How can you prepare?
Amongst other things, you should:
- assess what use is made of personal service companies;
- consider whether IR35 will apply to your business (including consideration of the small business exemption);
- review any current contracts with personal service companies in light of IR35, and the factors set out above;
- implement new policies and procedures which would build in an ‘IR35 assessment’ when onboarding any new contractors;
- ensure new contracts are appropriately drafted to reflect IR35 requirements; and
- decide what approach will be taken regarding personal service company's caught by the IR35 rules (e.g. whether the business will absorb this cost or share the burden with the personal service company via the renegotiation of fees).