IR35: what the future holds
Katy Ponsford explains IR35 rules and their implications
IR35 are the rules which apply to contractors who provide their services through their own limited company. As part of the current chancellor’s reversal of many aspects of his predecessor Kwasi Kwarteng’s mini budget, the government’s plan to simplify the IR35 rules from April 2023 have been scrapped. Therefore, IR35 is here to stay.
Many businesses, understandably, jumped for joy at the prospect of not having to comply with the IR35 rules, lifting what is considered to be a costly administrative burden on employers. The change would have resulted in contractors once again carrying the responsibility for determining their employment status and associated tax.
As a result of the U-turn, employers must continue to meet their obligations under the existing IR35 legislation.
Background to IR35
IR35 initially became law in 2000 after it was legislated within the Finance Act. It is another name for the off-payroll working rules.
The rules within the law have one primary purpose: to stop contractors working as ‘disguised employees.’ This is achieved by taxing the contractors at a similar rate to that of employment. It bears implications for all contractors who fail to fall within HMRC’s definition of ‘self-employed.’
According to gov.uk, someone is self-employed if most of the following are true:
- they put in bids or give quotes to get work.
- they’re not under direct supervision when working.
- they submit invoices for the work they’ve done.
- they’re responsible for paying their own National Insurance and tax.
- they do not get holiday or sick pay when they’re not working.
- they operate under a contract (sometimes known as a ‘contract for services’ or ‘consultancy agreement’) that uses terms like ‘self-employed’, ‘consultant’ or an ‘independent contractor’.
HMRC makes clear it will take a broad view of a contractor’s circumstances to determine whether or not they should be considered employed. Thus, all contracts should reflect one’s working practices.
Furthermore, three vital points are considered when a contractor’s working arrangement is assessed, with the aim of determining if they are ‘inside IR35’ or ‘outside IR35’:
· Right of Substitution: Substitution is the ability of a contractor providing a contracted service to supply a replacement contractor to carry out the service under the contract.
· Mutuality of Obligations (MOO): MOO means that in order for an employment relationship to exist, there must be an obligation on a work-provider to provide work and an obligation on the individual to carry out the work.
· Control: Control looks at whether a worker is truly independent when working under a contract between it and the end-client. The more factors showing independence of work behaviour, choice of how and when to work, etc., indicate a scenario where IR35 does not apply.
Prior to 6 April 2021, contractors held all responsibility for assessing if they were ‘self- employed’ for the purposes of determining their tax status. As the contractor was responsible for determining this status, and given the financial benefits that could be gained, unsurprisingly, most considered they were not an employee and avoided the PAYE regime.
To further bolster their position, ‘self-employed’ contractors would provide their services to the end user through a third party (usually a personal service company or PSC or through an agency or intermediary). Where the contractor used a PSC to receive the payments, they would often pay themselves a sum under the threshold required for income tax and NICs and top up their take-home pay through the payment of dividends.
The Government’s position was that they were missing out on tax and NICs to the tune of an estimated £700 million per year – and IR35 was born.
The IR35 rules place responsibility for the assessment of employment status on the end user who benefited from the services. Medium and large private companies became responsible for assessing whether the contractors they engage via intermediaries were a ‘disguised employee’.
The rule of thumb is that a contractor, who would otherwise have been an employee, may be caught by the IR35 rules. The majority of commentary available suggests that IR35 only covers PSCs and agencies. However, this is erroneous. IR35 can also apply to individuals engaged directly, but treated as ‘self-employed’.
HMRC are only concerned with whether an individual is employed of self-employed in practice, rather than what is set out in the contract between the parties. If the rules apply, income tax and NICs must be deducted from the fee payable to the contractor and paid to HMRC. This means that the contractor, who could once have gained a financial benefit, is now paid no more than the employees they work alongside.
For ‘small’ private companies, the responsibility for deciding whether IR35 will apply will remain the responsibility of the intermediary or contractor. Here, ‘small’ is used to mean companies with a turnover of no more than £10.2 million, with a balance sheet total of no more than 5.1 million and less than 50 employees.
For ‘medium and large’ companies, HMRC’s online tool can be a useful starting point for determining whether IR35 applies to a particular engagement, although it cannot be used if you employ the contractor directly. Do continue to keep records of your checks and tax status determinations.
Where you engage a contractor directly, you will need to determine employment status for yourself. There are numerous factors to consider, making such a determination and no particular factor is determinative in itself. This is where the help of an employment solicitor can prove invaluable.
In addition to considering whether the contractor is a ‘disguised employee’, end users should also issue a ‘status determination statement’ to the contractor and any other intermediary it contracts with, confirming the determination and providing reasons. Be sure you understand what you need to do.
Remember, HMRC have the power to claim backdated tax and NICs along with any accrued interest and a penalty. Companies have therefore been mitigating against the risk of an incorrect determination by including tax indemnities in their agreements. An undertaking that the contractor will comply with their obligations under IR35 is also helpful.
The controversy surrounding the changes rolls on. Nonetheless, in the meantime it is important to remain compliant with the current legislation. If you are unsure about the employment status of the people who work for you or with you, you should seek legal advice from an employment solicitor.
Katy Ponsford is an associate solicitor at Clarke Willmott clarkewillmott.com