What is IR35?
IR35 is HMRC's attempt to tackle individuals working for end
users through intermediaries/personal service companies (PSCs), where the
motive for that working arrangement is to reduce tax payments (in particular
employer's NICs, by far the biggest single tax cost to many businesses), rather
than a genuine intent to be self-employed.
With effect from 6 April 2021, the requirement to ensure working practices are compliant with IR35 is shifting to the end user.
This change will affect private sector businesses* who use consultants/contractors, where those consultants/contractors operate through intermediaries, such as PSCs (Relevant Contractors).
Why is the law changing now?
This reform follows an identical change (from April 2017) for organisations in the public sector that use Relevant Contractors. The changes are been introduced to make the task of ensuring individuals pay the appropriate level of tax easier for HMRC.
At the moment, HMRC is required to pursue the individual workers and their PSCs for what are often relatively modest amounts of tax. These changes will allow HMRC to pursue large employers (engaging multiple PSCs) to recover the same tax for a fraction of the recovery (and administrative) cost to HMRC.
What should I do to prepare for IR35?
On 6 April 2021, responsibility for compliance with IR35 is shifting from contractors operating through intermediaries (such as personal service companies, or PSCs) to private sector end users of the contractor's services.
Once the end user has assessed the worker's status, they are obliged to pass this information back to the worker, via any intermediaries.
If the worker is assessed as being employed for tax purposes, the entity nearest the PSC/intermediary in the labour supply chain will need to make deductions for tax – i.e., PAYE and National Insurance contributions (NICs), and withhold these from the contractor’s fees.
In some cases, that entity will be an employment agency or another contractor, but very often it will be the construction company who benefits from the contractor's services.
If they fail to operate the IR35 system, HMRC may pursue the construction company for taxes owed and they could also face fines or other penalties.
For the new IR35 tax rules to apply, there are certain key components that need to exist.
The individual worker must personally perform a service for an end user/client through an intermediary. The intermediary can be a PSC, limited company, agency, or partnership.
There is a small company exemption from IR35 for end user companies with a turnover of less than £10.2 million, a balance sheet of less than £5.1 million or 50 employees or less.
Businesses need to identify who they are currently contracting with, and on what basis. A carefully drafted contract does not automatically avoid problems in this area, unless it reflects the reality of the situation. A risk-based approach should be adopted and amendments made to working relationships where necessary.
Businesses should review their payroll systems, booking systems and other processes to ensure they have the capacity to apply PAYE to contractor pay, where necessary. If businesses opt to move workers on to payroll, they will need to consider:
- Staff budgets; there will be an associated PAYE cost (such as employer's NICs). These increased costs needs to be incorporated into budgets.
- Size of their HR team. Will the current team be able to cope with additional employees?
HMRC's 'Check employment status for tax' (CEST) tool has been the subject of widespread criticism and we encourage you to approach it with caution.
CEST has been criticised for giving undue weight to certain aspects when assessing whether an employment relationship exists (such as the right of substitution) and, in a large number of cases, failing to give a result at all.
The preparation stage is a good time for clients and their workers to engage in open conversations about their IR35 status. This can involve looking at the questions asked by HMRC's CEST tool and using them as a starting point for these discussions. This gives companies and workers a chance to smooth out any differences in opinion about the worker's status, before involving HMRC.
There will be some cases where clients and workers disagree over determination and, regrettably, the government is resisting a statutory framework to deal with such disputes, so clients should be aware of this risk and potentially seek legal advice on how to manage it.
This makes this area especially complex, and businesses need to be wary of falling into traps regarding the determination of workers' status.
One of the main areas of confusion around IR35 is what tax liability employment agencies, and those contracting with employment agencies, will face with respect to individuals they place, if those individuals are contracted through a PSC, or similar.
Unfortunately, there is no simple answer to this, as liability will be fact-specific.
While the responsibility for status assessment in these circumstances will most likely rest with the client of the employment agency, employment agencies also have the option of taking advice on the IR35 status of individuals and then passing this onto the workers and their clients.
This should ensure that the position is completely clear to all parties.
Every analysis needs to be tailored to the company, PSC or other intermediary, and the role of the individual concerned.
A good practical tip for employment agencies, and those contracting with them, is to make transparency a key contractual requirement.
The contract should ensure a flow of information between all concerned so that status determinations can be carried out and confirm who is responsible for operating PAYE.
If work is being provided to a business by a contractor who is not UK resident, this may fall outside the remit of IR35.
For IR35 to apply, the contractor needs to be a UK tax resident.
Tax residency rules can be complex, and this is something both companies and individuals should give due consideration to when assessing their IR35 status.
Whether IR35 applies will therefore be a question of fact.
Part time consultants operating through intermediaries, even those providing services to others at the same time, can still be caught by IR35.
When assessing an individual's IR35 status for a particular relationship, the fact that a person's engagements by other clients are not classed as employment is irrelevant.
A tribunal will look at the facts of the specific engagement to determine whether IR35 applies.
The ultimate aim of IR35 is for HMRC to boost tax receipts from workers who are wrongly benefiting from lower tax rates charged to companies, when they should be paying National Insurance Contributions (NICs) and PAYE on earnings in the same way as regular employees.
This raises the question of where the increased tax burden will fall once IR35 comes into force.
Contract workers may decide to increase their fees, while end users of workers' services may push for lower rates to compensate for having to pay employer's NICs for contractors.
How this plays out will depend on individual circumstances and is generally a commercial negotiation point, but it is likely that the overall cost of doing business in the UK will rise as a result of this legislative change.