April 2020 sees the expansion of IR35 from the public sector to all businesses.
The changes will shift the responsibility for operating IR35 rules from the contractor’s Personal Service Company (PSC) to the medium or large-sized organisation they work for.
What is the “IR35”?
Introduced by HMRC in 2000, this legislation is known as the “intermediaries legislation” or, more commonly, “IR35” (after the reference number of the HMRC Press Release announcing the rules in Budget 1999).
IR35 is an anti-avoidance tax legislation which sets the rules for how much tax contractors working through an “intermediary” (usually, but not necessarily, a personal service company (PSCs)) and who due to the way they were working and the nature of their work, would have been regarded as employees if engaged directly by the end user (the “client”), must pay.
Therefore, the rules are designed to tackle what HMRC call “disguised employment”.
To quote HMRC:
“The off-payroll working rules (commonly known as IR35) ensure that individuals who work like employees pay broadly the same income tax and national insurance contributions (NICs) as employees, regardless of the structure they work through.”
Because limited companies have certain loopholes, such as paying directors or “employees” in dividends that have lower rates compared to salaries, a rising number of contractors were setting up on their own companies, working as a “disguised employees”, to avoid tax and national insurance contributions (NICs), therefore reducing overheads.
It would appear that HMRC wanted to recoup tax from these contractors, but the legislation only existed to manage the relationship between the employer and employee, rather than demanding that a worker should pay more tax directly.
Where the relationship between the contractor and client would have been one of employment in the absence of the intermediary (i.e. the PSC), IR35 ensures that the contractor’s income tax and NICs liability is broadly equivalent to that of an employee and imposes a PAYE and NICs obligation on the intermediary (i.e. the PSC).
This article assumes that the intermediary is a PSC, unless otherwise stated.
What is changing in April 2020
Currently, where the client, in receipt of the contractor’s services is in the private sector, responsibility for ensuring compliance with IR35 sits with the PSC.
Therefore, until 6 April 2020 it is the contractor’s limited company’s responsibility to decide the contractor’s own employment status for each assignment.
However, it is HMRC’s view that many PSCs are not managing their IR35 obligations properly, meaning HMRC is suffering a tax shortfall.
Therefore, from 6th April 2020, new tax rules come in to force which:
- shift the responsibility for determining the employment status for tax purposes of off-payroll contractors from the individuals themselves to the client, for all payments by medium and large businesses. Therefore, making the client (being a medium and large business) liable to determine if the IR35 rules apply; and
- impose payroll obligations on the business that is paying the contractor (or the contractor’s PSC or other intermediary). Therefore, where an engagement falls within IR35, the liability to operate PAYE and pay employer’s NICs will sit with the entity that pays the PSC.
These changes bring the private sector in line with the tax rules for off-payroll workers in the public sector, introduced in April 2017.
These changes are not retrospective.
At the date of this article, the legislation is currently only in draft form, so the finer details of the legislation are awaited.
Ahead of the April 2020 reforms to the IR35 rule, HMRC has published draft statutory instruments for technical comment. The secondary legislation can be located here and outlines the amendments that are being made to PAYE and NIC regulations.
The draft legislation is open for consultation until 11:45pm on 19 February 2020 and comments should be sent to firstname.lastname@example.org.
Therefore, from April 2020, medium and large private sector organisations, will be responsible for carrying out an assessment to determine whether a contractor’s PSC roles are inside or outside IR35 legislation.
The new rules will only apply to medium and large businesses in the private sector who are the end user of the contractor’s services and to the fee payer, if different, such as fee payers in the recruitment sector.
Small Company Exemption?
The new IR35 rules will only affect medium and large private sector organisations, so “small” end clients are set to be exempt – the definition of which is based on the Companies Act 2006 definitions.
The Government have indicated that they intend to use “similar criteria” to that found in the Companies Act 2006 to define a medium-large business.
Under current legislation this is broadly a business that has two or more of the following features:
- a turnover of more than £10.2m; or
- a balance sheet total of more than £5.1m; and
- 50 employees or more
How do I know if IR35 applies to me?
- where a contractor provides services to a client/hirer through a PSC or other intermediary (i.e. a partnership or other individual); and
- the working arrangements are such that if the contractor provided the services directly, they would be regarded for income tax purposes as an employee of the client/hirer.
IR35 applies on an engagement-by-engagement basis and hence the underlying arrangements in relation to each client must be assessed individually.
The IR35 status for each engagement is judged on its own merit.
Engagements for the provision of goods, rather than services, are completely outside IR35.
Sole traders are also excluded because there is no intermediary. For sole traders the issue is purely one of employment status.
Services provided via a partnership or by another individual are within IR35, but these arrangements are rare in practice.
A contractor could be “inside IR35” in respect of certain engagements whilst being “outside IR35” for other client engagements.
“Inside IR35” or “Outside IR35”
From 6 April 2020, it will be the client’s responsibility to determine whether the IR35 rules apply, i.e. is this assignment “inside IR35” or “outside IR35”?
To be “inside IR35” means that the contractor is considered, for tax purposes, an employee of his client and therefore subject to PAYE.
If the contractor’s role is deemed to be inside legislation, the contractor will be subject to PAYE and NICs deductions.
The fee-payer (i.e. the client or recruitment agency) will be required to deduct the contractor’s tax and NICs at source.
To be “outside IR35” means that the contractor is operating as a genuine business, and therefore operating outside of the IR35 rules.
If the contractor is operating “outside IR35”, he is able to pay himself a salary, draw the remainder of income as dividends, and remain responsible for his taxes as usual.
Status determination statements
To make a determination of “inside IR35” or “outside IR35” hiring organisations/clients will be required to provide a “status determination statement” to both the contractor and next party in the chain to be passed to the fee-payer.
The “status determination statement” must include both the status decision that was made, as well as the reasoning behind it. Beyond these criteria, HMRC have offered no further guidance as to what this should look like.
To make such determination the hiring organisation/client must ensure that “reasonable care” was taken during the decision-making and that the decision itself is reasonable.
If the client does not exercise reasonable care, the status determination statement will not be valid, and the client will be liable for the unpaid taxes. HMRC have confirmed that it will issue further guidance on what constitutes “reasonable care”.
This tool applies to both public authority and private engagements.
HMRC is not compelled to stand by any result given by CEST, but it has said that it will do so unless a compliance check finds the information provided by the client when using the CEST tool is not accurate.
However, feedback on the CEST tool is varied and the HMRC’s tool is widely regarded as flawed, so clients should cross-reference this by consulting with IR35 specialist advisers.
Determining whether the engagement is inside or outside IR35
To determine whether a contractor will fall inside IR35, key criteria are reviewed to establish employment status.
As explained above, IR35 applies where a contract of employment would have existed between the worker and the client, had there been no PSC.
This aspect of IR35 is thus based on the fiction that there is a contract directly between the client and the worker. This is known as the “notional” or “hypothetical” contract.
In working out what would have been the terms of this notional contract, it is necessary to look at “the circumstances” in which the services are provided.
These circumstances are factual and include, but are not limited to, the terms on which the services are provided to the client having regard to the actual contractual arrangements between the client and the PSC.
What makes things more complicated though, is that there isn’t a set of formal guidelines either the client or the contractor can refer to in order to decide whether the contractor should be considered an employee or a contractor.
It’s all down to discretion.
However, if the contractor:
- Works onsite in the organisation every day;
- Uses equipment provided by the organisation rather than their own;
- Manages people within the organisation;
- Uses employees from the organisation to work on the project,
then it’s pretty likely they would come under the scope of IR35 and their position should be carefully examined.
However, the route to determining employment status is fact-specific and in some cases, there is no clear outcome.
A significant amount of case law has arisen in the specific context of IR35 and how it applies for NICs purposes.
The principles established are equally relevant for income tax purposes.
The case law is largely concerned with determining what the “notional” contracts would contain, and whether they would be employment contracts.
Features which may point towards or away from employee status are: (Please note that this is only a brief guide; it is not intended to be a comprehensive analysis of employment status.)
|Whether the worker|| Towards |
| Away from employee |
|provides services personally||Yes – required|
|is subject to a sufficient level of control by the employer||Yes – required|
|and the employer share mutuality of obligation||Yes – required|
|a regular wage or salary||Yes|
|via profit sharing or the submission of invoices for set amounts of work done||Yes|
|assumes a degree of financial risk if work is not completed on schedule or to standard||Yes|
|receives any performance-related pay, such as a bonus||Yes|
|receives overtime pay||Yes|
|provides their own workspace, tools and equipment||Yes|
|is not tied to the employer, ie free to work for others (especially rival enterprises)||Yes|
|works variable hours or variable days of the week (or works only for certain fixed periods)||Yes|
|works on specific projects or not at all||Yes|
|works in a trade whether there is a ‘traditional structure’ of employment||Yes|
|has their attendance and hours of work monitored||Yes|
|is subject to the company disciplinary procedure and other procedures and policies||Yes|
|maintains indemnity insurance||Yes|
|maintains employer’s liability insurance, where they employ staff||Yes|
|receives paid holiday||Yes (although note this is a worker’s entitlement)|
|receives sick pay||Yes|
|receives other benefits (such as subsidised gym membership, medical expenses insurance)||Yes|
|is ‘part and parcel’ of the employer eg:|
|participates in staff training||Yes|
|participates in staff events eg Christmas parties||Yes|
|has an employee (as opposed to a visitor or temporary ID) pass to the employer’s premises||Yes|
|is responsible for the payment of income tax and national insurance contributions||Yes|
|can be dismissed||Yes|
|has a long engagement, or series of engagements||Yes|
The Government’s Employment Status Manual is intended to provide guidance on issues relating to the employment status of individuals. You can read the guidance here.
Tax adviser Qdos Contractor explains the main status test that need to be considered to assess IR35, which can be found here.
Can the contractor be involved in the client’s status determination?
Whilst there is no statutory right for contractors to be consulted during the status determination process carried out by their client, it is expected that contractors will be involved to some degree in the client’s status determination process, as there are some questions in the HMRC CEST tool or similar tools which have been created, which require the contractor’s input – for example questions on how the contractor runs his business.
The draft legislation imposes an obligation on the client to provide a “client-led status disagreement process”, either the recruiter or the contractor may disagree and follow the process.
The client must respond to a request to review the status determination statement within 45 days.
The client must either confirm the determination is correct, with reasons, or provide a new status determination statement reaching a different conclusion and withdraw the previous one.
If the contractor disagrees with the client’s determination, the contractor will need to write to the client and give reasons why.
Contractors need to ensure they keep records of status determinations and any corresponding disagreements.
During the dispute process the client’s determination stands.
If the IR35 proposals are legislated in their current form, where HMRC disagrees with the determination made, it can investigate and insist on back payment of tax, as well as fines for late payment from the fee-payer.
How could it affect me?
All public sector authorities and medium and large-sized private sector clients will be responsible for determining whether the rules apply – i.e. are you “inside IR35” or “outside IR35”?
Where the private sector client is considered “small”, your PSC will remain responsible for deciding the contractor’s employment status and whether IR35 applies.
What isn’t taken into account by IR35 is the loss of benefits a contractor has when they are not directly employed by a company, specifically things like paid holiday, maternity or paternity pay, private health insurance or a pension with contributions paid by the employer.
Therefore, as an “inside IR35” contractor, you will not benefit from any “employee rights” such as holiday pay, sick pay, pension contributions, dismissal rights etc.
You may receive these benefits through your employment in your PSC.
If your assignment falls “inside IR35”, it is likely that you are no longer in business on your own account and could be within scope of the Agency Worker Regulations (AWR).
Under AWR, you are entitled to comparable pay to a permanent employee on the client site.
If you opt to engage via an umbrella company, you are an employee of the umbrella company and therefore you will benefit from employment rights and AWR will apply.
There is currently still some uncertainty and debate in the market around the full impact of the changes, and the consequences for PSC contractors.
Experience of the IR35 legislation being introduced in 2000 suggests that the IR35 reform has had a significant impact on genuinely self-employed contractors.
It is expected that such impact will continue following the implementation of the April 2020 changes.
In theory, IR35 shouldn’t affect the genuinely self-employed, but in reality, following public sector reform implemented in 2017, a number of organisations, made blanket decisions placing their entire contractor workforce inside IR35 to protect their liability.
This, along with many inaccurate IR35 decisions, could place many genuinely self-employed contractors inside IR35, resulting in the contractors paying similar taxes to employees, but without any of the benefits.
For those that are genuinely self-employed, the reforms should have minimal impact, but there is evidence that some enterprise clients are in panic mode and taking the sledgehammer approach, which will result in some contractors being incorrectly engaged as employees.
It is hoped that once they witness other educated enterprise clients correctly engaging their self-employed workers outside of IR35 correctly, there will be a rebalance across the marketplace.
The desired positive of these reforms is that they will cleanse the industry of the contractors currently deemed as outside of IR35 but who are, in fact, engaged in employed assignments.
Whether this will happen in practice, remains to be seen.
A sensible exercise would be for contractors to sit down and reflect on how they actually work in practice on each of their engagements.
For further information or to discuss a matter, please contact me.
This content is provided free of charge for information purposes only. It does not constitute legal advice and should not be relied on as such. No responsibility for the accuracy and/or correctness of the information and commentary set out in the article, or for any consequences of relying on it, is assumed or accepted by Adriana Badescu.