WHAT IS IR35?

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Do you provide your personal services to an end-client through a limited company? If the answer is yes, then you’ll need to ensure you act in a way which doesn’t look look to HMRC like an employer and employee relationship.

Why is this so important for contractors using a limited company? Well, if HMRC deems you as an employee rather than a business - the amount you pay in tax differs.

HMRC wants to make sure the tax you pay accurately reflects your employment status. These rules are enforced by HMRC through ‘intermediaries legislation’, otherwise known as ‘IR35’. It’s also, rather confusingly, referred to as ‘disguised employment' or 'off-payroll working' rules.

IR35 is notoriously complicated to grasp and, when trying to wrap your head around this complex legislation, online information and even HMRC’s own guidance can often be more confusing than helpful. This guide will explain IR35 in simple terms, and provide a few scenarios to better equip you to understand if you’re paying tax correctly under IR35.

What is IR35 and why is it important?

A very brief history - IR35 was introduced in 2000 to address the problem of people working through personal service companies to avoid paying employment taxes. It was designed to make sure workers and employers pay the right amount of employment taxes, particularly where employed workers and self-employed contractors were undertaking similar work.

Through a limited company, you’re able to split your income and the associated Income Tax and National Insurance Contributions (NICs) based on a low salary and high dividends – thereby paying less tax than an employee.

If IR35 applies to your contract, it means you pay the same Income Tax and National Insurance contributions (NICs) as you would if employed directly rather than contracted to work through your limited company.

The financial impact of IR35 can be significant. You may find your future earnings are reduced and have to pay Income Tax and NICs it calculates as due from prior years.

HMRC can determine if the relationship between you (as the worker) and the end-client would be seen as an employer/employee relationship, if the agency you work for and/or your limited company wasn’t in place. Breaking it down: IR35 determines if you’re an employee of the client or whether your limited company is providing services to that client.

There were a number of changes to the IR35 rules that were scheduled to be rolled out for private sector businesses in April 2020, but the COVID-19 crisis means this has been delayed for another year. Businesses now have an extra year to plan for the changes, now set to be implemented on 6th April 2021. We’ll cover the changes later in this guide.

Before we start, here are some terms you’ll come across on this page:

Personal Service Company: a company that sells the work or services of an individual (or group of individuals) that is owned and operated by that individual (or group of individuals).

Intermediary: the entity that sits between the end-client and the worker, such as the agency or limited company.

End-client: the company that is actually engaging the contractor or personal service company to carry out work for them.

Am I an employee or a contractor?

You might imagine this would be a fairly straightforward process. You may think that because you have a limited company and the work isn’t permanent, you’re a contractor. Well, unfortunately, it isn’t that black and white, and there’s a variety of questions you should ask to establish your employment status.

It’s important to remember that IR35 is designed to cover a large number of scenarios. There is no single situation to prove IR35 rules apply or not. What is important is that the contract between your limited company and the agency or end-client, and the actual working practices you follow, clearly show that you should not be regarded as an employee of the end-client you are providing services to.

HMRC are becoming increasingly tough with regards to IR35 enforcement. In the public sector, they introduced changes for public sector assignments in 2017 that put the responsibility on the end-client (or agency) to determine the IR35 status of people providing services via limited companies. This has led to an increase in the number of contracts deemed to be ‘inside IR35’ in the Public Sector and an increase in the amount of employment tax paid to HMRC. As we mentioned above, the government intend to implement similar rules for most of the private sector in April 2021. This means it’s important to be able to show that you’re not a ‘disguised employee’ of your end-client and that you are working legitimately as a contractor through your limited company.

The first thing to consider when approaching IR35 is whether your work is controlled and directed by you, or if you are subject to an employer/employee relationship.

FAQ

Someone oversees my work, does this mean I’m caught by IR35?

On its own, supervision or quality control does not mean IR35 rules automatically apply. IR35 rules could apply if other working practices were similar to those between an employer and employee. For instance, if you report to a line manager every day, you are set performance targets to achieve, and your reward is linked to achievement, it’s possible you are being supervised and therefore IR35 rules apply.

What exactly is meant by control?

Control is usually evident if your end-client directs where, how and when you complete your contract assignment. However, if you have the freedom to work when you want, at a place of your choosing and using your own tools/materials, then control is probably not being exercised by the end-client.

What happens if I’m on a retained fees contract?

If a client pays a fixed sum to keep you on standby in case your services are required in an emergency, then IR35 rules may apply because the end-client is exercising control over you.

Can I be caught by IR35 if I’m no longer working for that client?

HMRC can look into your employment situation for contracts going back up to 20 years if there is evidence of deliberate avoidance of employment taxes. Any taxes due from previous years may be payable.

Factors that affect your IR35 status

How do I know if IR35 rules apply to my contract

Determining whether IR35 applies is complex and must be considered at the individual assignment level. HMRC will also look ‘behind’ your contract with your end-client and at the actual working practices being followed - so it’s not just a 'paper exercise'. You should seek specialist advice. However there are three key principles that will determine your IR35 status, and your end-client has the right to do the enforce the following:

Control: What degree of control does your client have over what, how, when and where you complete the work?

As a contractor, it's likely that you'll work to a comprehensive job specification. This specification would outline the following:

The services to be provided
Where the services are provided
The hours in each day over which the services are provided.

However, the contract may go further and say that you must submit to management guidance, appraisal or monitoring. This is an indicator your work is being controlled and that you’re an employee, not a contractor.

Substitution: Are you required to carry out the work yourself, or can you send someone else in your place? If you have to provide your services personally, this is usually an indicator that you’re an employee. A contractor, on the other hand, could send a substitute to complete the work on their behalf. A contractor could also reassign the work. However, the right to send a substitute must be absolute and not restricted to such an extent that you have to perform the work yourself.

Mutuality of obligation: Does the contract oblige your client to offer you work throughout the contract period, and are you obliged to personally do the work? When the contract period ends, is there an obligation on the end-client to offer you you further work and extend the contract?

To qualify as a contractor, there can’t be any ‘mutuality of obligation’. There are three obligations to consider:

An obligation for one party to offer other work within the assignment
The worker has an obligation to complete a notice period of similar length to that if they were an employee.
If work is offered, an obligation for the other party to accept it.

Put simply, a contractor must work on a project to project basis, with no obligation to carry on working for the end-client after the project has been completed.

A contractor also has the right to terminate a project partway through. To qualify as a contractor, make sure these apply to you and that there is no ‘mutuality of obligation’.

Regardless of the sector you work in, these three key principles remain the same. If you can clearly show that any one of these principles does not apply, you should not be affected by IR35. This is because the relationship with your client will be seen as a contract for services, rather than a contract of employment. For example, if a worker can send a substitute in their place, and that decision is not fettered in any way, personal service is not required and IR35 does not apply.

As well as the three key areas highlighted above, you also need to be aware of some additional factors.

Financial records: A contractor will receive payment when work is completed, while an employee will usually be paid at regular intervals.

Alternative work: If you’re contractually obliged to have one client at a time, you’re probably an employee, not a contractor.

Equipment: Unless there’s a sound reason (such as for safety, security or practicality) you should be using your own equipment, rather than equipment supplied by your client.

Corporate involvement: You could be affected by IR35 if you have any involvement at all with your client’s corporate structure. This applies to even the smallest involvement, such as whether you have a security pass to your client’s building.

Blacklists: Check to see whether your client has had any IR35 problems in the past.

IR35 in the public and private sector

Public sector

Following changes introduced by HMRC on 6th April 2017, the responsibility for determining your IR35 status depends on the sector you operate.

In the public sector, responsibility now lies with the end-client (or agency) who pays your limited company. If your contract is inside IR35, this same end-client (or agency) will pay Income Tax and NICs (employer’s and employee’s) to HMRC.

Private sector

The government published a consultation in May 2018 to extend the IR35 rules operating in the public sector to the private sector. These are scheduled to be introduced on 6th April 2021.

In the meantime, we recommend contractors working in the private sector ensure they understand what their IR35 status is and seek professional advice if needed.

What changes will there be in the private sector?

We’ve summarised the main changes and impacts below.

The end-client will be responsible for determining whether an assignment is inside or outside of IR35 rules.

The changes for the private sector mean the end-client will be responsible for determining the IR35 status of an assignment with a Personal Service Company (PSC). The rules will be consistent with the changes brought in for the public sector in April 2017.

Small business exemption to new IR35 rules

The new rules apply to ‘medium or large’ sized businesses in the private sector and all organisations in the public sector. There’s an exemption for end-clients who are 'small businesses' as defined by the Companies Act 2006, which means meeting two or more of the following criteria:

Annual turnover is no more than £10.2 million
Balance sheet total is no more than £5.1 million
No more than 50 employees.

Where the end-client meets two or more of these criteria, responsibility for determining the IR35 status of an assignment remains with the PSC and the new rules do not apply.

The government has included clauses in the legislation to ensure medium or large- sized businesses do not set-up arm’s length companies or subsidiaries to procure services from PSCs. The legislation will apply to the parent company based on the aggregate amount of turnover and the aggregate amount of the balance sheet total of the connected entities.

There’s no small business exemption for public sector organisations and the legislation will apply to all end-clients engaging PSC workers in the public sector.

IR35 Status Determination Statement (SDS)

Once the changes are brought in (which will be April 2021 at the earliest) the end-client must confirm the IR35 status of an assignment by providing a 'Status Determination Statement’ (SDS). The SDS must be provided in writing to the PSC worker and, if an agency is involved in the labour supply chain, a copy must be provided to the agency responsible for paying the PSC. The SDS must be provided to all parties before the assignment commences.

These arrangements place most of the responsibility for administering an SDS on the end-client and/or the fee payer (if an agency is involved).

IR35 status dispute resolution process is led by the end-client

It’s the responsibility of the end-client to establish arrangements to consider any disputes from PSCs about the SDS. The legislation does not specify how such arrangements should work in practice but does state a time limit of 45 days to respond, in writing, to the PSC with the outcome of the review of the dispute. The decision must either confirm the original SDS is upheld, or, if it involves a revised SDS or conclusion, a new SDS must be provided in line with the arrangements outlined above.

Transfer of employment tax liabilities to another relevant person

The legislation is designed to ensure the organisation with responsibility for issuing the SDS, or the fee-payer if an Agency is involved, is responsible for any employment tax liabilities arising.

The legislation also allows HMRC to recover tax liabilities from another ‘relevant person’. A relevant person is any party involved in the payment to a PSC. This means HMRC can recover tax from the highest party in the labour supply chain which is not complying with the legislation. HMRC believes this will ensure compliance with the rules across all parties involved in the labour supply chain.

5% administration allowance withdrawn (mostly)

The new rules, when they are introduced, will remove the 5% allowance for PSCs to meet the costs of administering the off-payroll working rules. The allowance will continue for PSCs working with ‘small’ end-clients in the private sector as defined above.

Check of Employment Status Tool (CEST)

The government updated the Check of Employment Status Tool (CEST) in November 2019. Even after these changes, though there are still a number of concerns about the accuracy of the tool.

What if my end-client or agency says I’m inside IR35 but I don’t believe I should be?

As you can see, IR35 rules are complex. If you disagree with a decision made by your end-client about your IR35 status, you should immediately seek professional advice. Ideally, this should be before you start working on the assignment.

Karia Accountants can help with this. Our expert accountants advisors will look at a case completely impartially and use their experience to make a recommendation so you know where you stand.

You should then present your advisor's opinion to the end-client and ask them to reconsider their position. Often there might be factors the end-client hadn’t thought about during its assessment of IR35.

If your end-client’s view doesn’t change, you’ll need to contact HMRC and ask them to review the decision. However, this can be a long process and may involve providing evidence to a Tribunal. You may need professional advice throughout this process.

Once the new rules are introduced, the dispute process will be handled by the end- client. Again one of our detailed reports or a contract review from an accountant will be helpful in showing your end-client what the correct IR35 status should be.

What is IR35 an why is it so important