What is IR35?
IR35 tax legislation has been in place since 2000 - reforms were made with respect to the public sector from April 2017 and as of this month are now in place for private organisations (delayed by one year due to COVID-19). Essentially, the legislation was brought in to ensure contractors (off payroll) and employees (on payroll) are subject to comparable tax deductions when they are undertaking the same role.
Historically, an employee could resign from a role within a company with the sole intention of setting themselves up as a limited company entity. That individual would then 'return' to the company to be contracted back (providing exactly the same service) with the benefit of paying less tax on earnings since they can now draw earnings from dividends rather than be paid directly as an employee.
HMRC and the 'deemed employee'
The above scenario is what HMRC defines as “bending the rules of the tax system to gain a tax advantage that Parliament never intended.”
In reality, the contractor-business relationship is more akin to employee-employer - the contractor should be a 'deemed employee' and be taxed accordingly.
The obvious downside to this closing of the tax loophole is that many individuals running a Personal Services Company (PSC) have set themselves up as a limited company and could be legitimately operating in good faith. Organisations may decide to stop using a PSC to avoid any future tax liabilities and the administrative burden that comes with it.
Critics also point out that a contractor may now be judged to be a 'deemed employee' without the employment benefits that on payroll personnel have access to - such as sick pay, holiday pay and entitlement, pensions and so on.
Suffice to say tax legislation is not always compatible with employment legislation.
What are the changes to IR35?
As we've said, IR35 legislation has been around for some time but the key point now is that it is no longer the responsibility of the contractor to assess if they are a 'deemed employee'.
For middle and large sized companies in the private sector, it is now down to them to make the assessment.
Public sector fee payers have been required to administer IR35 since April 2017; the reforms to the original legislation in 2000 are now being rolled out to the private sector.
Should HRMC investigate a case of an individual working outside IR35 when deemed to be working inside IR35, it has the powers to investigate undertakings going back 6 years, can insist that the missing tax is paid, can hand out penalties and apply interest to any payments owed.
From April 2021, responsibility for assessing contractor or employee status will reside with the fee payer - and it will be their responsibility to calculate National Insurance Contributions and income tax - these elements will be deducted from a raised invoice.
In real terms, for an individual contractor with an annual salary of £40,000 now deemed to be inside IR35, the payroll deductions equate to around a £3.3k deduction in take home pay so it's vitally important that all parties understand the implications and make the proper assessment of any contractors hired for a particular role or project.
Are all private companies affected by IR35 reforms?
Well no - there's set criteria that needs to be met and HMRC defines middle and large companies, in this instance, as being:
- Turnover in excess of £10.2m per annum
- Having a balance sheet greater than £5.1m
- Employing more than 50 staff.
Companies ticking 2 or all of these will be affected by the new IR35 regulations.
Say goodbye to the blanket policy
Prior to the new IR35 changes when contractors themselves were responsible for assessing whether they were inside or outside the terms of IR35, some large companies practised a blanket policy of not contracting Personal Services Companies. Now the fee payer is responsible, they must assess each contract individually and a blanket policy will no longer be acceptable.
This IR35 reform has as upside and downside:
On the plus side
Freelancers and lone contractors may see avenues of work opening up for them as companies cannot apply a blanket policy. Supporters of the reforms say that contractors who operate 1-2 days a week at one company, and 1-2 days for another needn't be concerned since they are operating within the spirit of IR35.
And where IR35 reform may not be so good
In areas of skills shortage - in STEM and IT services for example, it's arguable that the reforms will have more impact and contractors with these skills will be hit hardest.
Also consider the huge administrative burden on private companies when it comes to assessing contracts, making the necessary deductions and reporting back to HMRC.
It's positive say some
Colin Morley, Director at Hays:
'We’re confident that companies will evolve how they engage with skilled contingent workers, particularly in the technology and engineering sector for example. This will see contractors being used more strategically to deliver specific outcomes.'
Tania Bowers, Legal Counsel and Head of Public Policy for the Association of Professional Staffing Companies (APSCo):
'It is unlikely that Off Payroll will stop businesses of any size from engaging independent contractors in the longer term. Instead, we expect the recruitment and deployment of these individuals to be more structured, which will in turn lead to an increase in project style delivery across organisations.'
What is 'deemed employment' and how is it assessed?
It is widely recognised that assessing 'deemed employment' is complex.
There is government guidance to help assess status and the HMRC IR35 CEST tool (Check Employment Status for Tax) informs as to whether the HMRC will deem a contractor employed or self-employed. Details of the contract proposed are needed before the checking process can be started.
The criteria below establishes whether there's an employee-employer relationship (i.e. 'deemed employment') or a business to business one.
Non Payroll Indicators:
- Personal Service - can a substitute worker carry out duties if the contractor is unable to fulfil the contract?
- Control - can the contractor dictate how the work is delivered?
- Mutuality of obligation - does the client provide consistent and paid work? This is arguably a contentious area and can be difficult to assess.
Then there are other factors to consider:
- Financial Risk - does the contractor hold business insurance liability? Are any work issues resolved at the contractor's cost and time?
- Non-Exclusivity - does the contractor hold other contracts or is disallowed from carrying out services for other clients?
- Equipment - does the contractor own the equipment?
- 'Part and Parcel' - is the contractor an integral part of the company (for example, uses the organisation's email signature, is on employee lists, has a contractor's ID badge?)
- Business Trappings - does the contractor own business cards? Does the contractor receive employee benefits such as holiday and sick pay?
These factors and others (is it a rolling contract or one that has a start and end date) can be used to assess deemed employment status.
(We recommend you contact us if you would like advice and guidance about the assessment of deemed employment status.)
Advice to contractors
Taking these indicators and factors into consideration, it is advisable for any individual to maintain evidential records for the duration of each contract they undertake.
Keep emails showing that your business signature is different to the company you are contracted to, demonstrate you have notified the company of your absence (rather than seek permission), provide written evidence that you have refused to undertake work not specified in the contract.
These are just some of the ways you can demonstrate a business to business relationship which will fall outside IR35.
As a private company I need to be IR35 compliant - what do I do first?
Our recommendation at Q&A would be to get in touch with us for our expert advice.
In our view, the first steps would be to:
- Take a balanced approach to implementation of IR35 rules. The fundamentals of the legislation haven't changed and for the majority of contractors, they will still sit outside IR35.
- Don't take PSC workers out of your business strategy - take time to understand the reforms and don't take a blanket policy approach to this innovative and creative section of the workforce.
- Put a process in place to determine the status of each contract undertaken.
- Audit recruitment partners - are they following the correct protocols?
IR35 reforms - a summary
Unquestionably there is an administrative burden in adhering to the new IR35 rules that come into effect this month.
However, if all parties in the supply chain are transparent, honest and communication is encouraged then assessment accuracy and thereby compliance is more likely to be achievable.
How can Q&A People Matter help you?
We can help steer clients on what they need to be doing in order to assess a non-payrolled individual’s employment status. We'll guide you through the process of determining Deemed Employment Status and what that means in terms of associated responsibility.