What is IR35?
IR35 is a complicated set of tax laws that form part of the Finance Act and impacts contractors, freelancers and interims operating via their limited companies. The first piece of legislation came into force in April 2000 and is otherwise known as the Intermediaries Legislation.
IR35 is designed to reduce tax avoidance by contractors who HMRC believe to be “disguised employees”. People who work in a similar way to full-time employees but bill for their services via their limited companies to make their business as tax efficient as possible but whose relationship with their client is such that had they been paid directly they would be employees of the client are considered to be ‘disguised employees’.
IR35 aims to address the group of contractors who;
(a) operate through an intermediary company, typically a personal service company (PSC) which is a limited company that they own, and
(b) would otherwise be classed as employees in the absence of the intermediary. For example, working permanently and full-time for a single client (that resembles an employer).
The majority of these transactional relationships are genuine, and there are plenty of sole trader limited companies operating in the UK. However, it’s not uncommon for some organisations to pay people in this way so that they can avoid paying employers’ National Insurance contributions or providing employment benefits.
When is this happening?
In April 2017 the Government introduced the "Off-Payroll Reforms", which is a separate piece of new tax legislation that applies to the public sector, but which is also referred to as "IR35". The Government is replacing the original IR35 legislation with the new Off-Payroll Tax, which was initially introduced into the public sector in April 2017, and will be extended to the private sector from April 2020.
What is the new Off-Payroll Tax?
The new Off-Payroll tax came into force by HMRC as it became apparent that the original rules were unenforceable. Whilst they both contain the common theme of "deemed employment", the newer rules introduce a different set of tax treatment, meaning that organisations will now have to assess the contractor’s status, but, more importantly, pay employment taxes on top of the fees paid to the contractor.
Why did the government introduce IR35?
IR35 legislation ensures that contractors pay the same tax and National Insurance contributions as an equivalent employee would. The new changes to be implemented in April 2020 for private sector contractors will transfer responsibility from contractors to large and medium companies to assess IR35.
Since 2000, contractors have been responsible for self-assessing their IR35 status and National Insurance Contributions. This arrangement has been ineffective and HMRC estimates that, under current rules, the cost of non-compliance in the private sector would escalate to £1.3bn by 2023/24.
Another problem that has contributed to the changes is the scenario where an employee ceases their employment with their employer on Friday only to return on Monday to do the same role in the same location. The difference of course is that they return as a contractor or consultant trading through a personal services company and pay less tax.
This can also save the engaging organisation a significant amount of cash, as they no longer have to pay employers’ NICs of 13.8% or the Apprenticeship Levy of 0.5%. It also means they do not have to offer any employment rights or benefits.
Who will IR35 affect?
IR35 is not only determined by the contents of a written contract, but also looks at the actual working practices. When the working practices do not reflect the contractual terms, the working practices will take precedence over the terms of the contract. There are many aspects to consider when determining whether a contract is subject to IR35, but the two most important factors are;
Control (right of): what degree of control does the client have over what, how, when and where the worker completes the work.
Substitution: is personal service by the worker required, or can the worker send a substitute in their place?
If the client has no right of control over the manner in which you carry out your work and you have the right to either send a substitute worker in your place or sub-contract some of the work or engage other workers to assist you, then it is likely that your contract will fall outside of IR35.
Other factors are then taken into account to determine whether you are caught by IR35 include the contract type, provision of equipment etc. HMRC will apply an employment test to each case that is based on the actual working practices rather than the contract.
All of this evidence is taken into account, and if the balance of probabilities is that the worker is an employee then IR35 applies.
Where the client or end-user is a small business, the PSC will continue to be responsible for assessing if IR35 applies. Small business, for the purposes of IR35 are;
If the client or end user is larger than this, they have to make the decision on IR35.
Can IR35 be avoided?
IR35 can’t be circumvented by organisations, other than to make the choice to engage all contractors on fixed term contracts (FTC). This would be an expensive, albeit less complicated way of dealing with IR35. Larger organisations would then have to negotiate with all the contractors they are currently engaged with to take a significant cut in rates in order to cover the additional costs although could be a solution for smaller businesses that don’t use interims that often.
However, for organisations engaging self-employed contractors, IR35 will not apply. That does not prevent HMRC from launching an investigation at a later date. For those who wish to engage interims outside IR35, and mitigating any IR35 risk they can use IR35 tests to determine if this is correct.
What are the main changes to IR35?
The new IR35 legislation to be introduced in April 2020 shifts responsibility for assessing IR35 obligations from the contractor or PSC to the end-user, which is the company that is the end client.
Where the client concludes that IR35 applies, the ‘fee payer’ (which may be the end-user themselves, a recruitment company, or other third party paying the intermediary) will be responsible for accounting for and paying the related tax and NIC to HMRC, including the additional cost of Employer’s NIC.
Under the proposed changes, the new rules aim to reduce the cost of non-compliance and make it easier for HMRC to monitor and enforce compliance in the future.
However, determining whether you are caught by IR35 is complex, and ideally you should seek expert IR35 advice.
Further Reading and IR35 Resources
HM Government Good Work Plan, December 2018 (PDF)
IR35: working through an intermediary (gov.uk)
Guidance: Off-payroll working through an intermediary (gov.uk)
Policy paper: Rules for off-payroll working from April 2020 (HMRC, 11th July 2019)