IR35 is a very hot topic at the moment. It isn’t however a new thing, but from April 2020 there will be some additional changes which affect the private sector. We have therefore outlined the impacts this will have and what, specifically needs to be considered in light of these changes.
Why was IR35 introduced?
IR35 is ultimately designed to close the loop hole where contractors set up a limited company to pay less tax when in effect; the relationship is more of an employer-employee status. They are therefore viewed by HMRC as ‘disguised employees’ and the contractor should be taxed as an employee. This is referred to as ‘deemed employee’.
The IR35 legislation ultimately looks to identify ’deemed employees’ and ensures they are taxed correctly.
IR35 changes were introduced to the public sector in 2017 with changes to the private sector announced in the 2018 budget, set to come in to play in April 2020.
It largely impacts UK Personal Services Companies. This is a term which hasn’t been clearly defined by HMRC but generally refers to a limited company with a sole, or majority director/shareholder who provides the services of the company.
When looking at the role of a Contractor it is important to establish whether their role is deemed as either Inside IR35 or Outside IR35. But what does this mean?
If a contract is Outside IR35, the worker is considered to be self-employed for tax purposes and can therefore pay themselves in the most tax efficient way which is ordinarily in the form of a combination of salary and dividends taken from their limited company. The worker is therefore fully responsible for ensuring their personal and company taxes are calculated correctly and paid on time.
If the contract is deemed to be Inside IR35, the worker is considered an employee for tax reasons. Therefore they are required to pay tax at the same rate as an employee in the same tax bracket and this will be deducted by the employer.
It’s worth noting however, that tax and employment legislation are currently separate. Therefore, whilst they may be considered an employee for tax purposes, they are not automatically entitled to employment rights.
Who is responsible for determining IR35 status?
In the private sector, prior to April 2020 it has been the responsibility of the limited company performing the work to determine the status of the contract.
However, from April 2020, all medium and large-sized companies will be responsible for determining the workers employment status. If an Employment Agency is used as a mid-person between the employer and employee, the responsibility for determining the relationship will fall to them.
If a company is seen to be a ‘small’ in HMRC terms, then the responsibility for determining the employment status will remain with the person supplying the services (the Personal Services Company).
HMRC determines a small company as one which does not exceed two or more of the following criteria:
An annual turnover above £10.2 million
A balance sheet total over £5.1 million
More than 50 employees
How is your IR35 status determined?
It can be difficult to determine an employee’s IR35 status because, whilst there are recognised tests to consider, it is more about painting a full picture rather than running through a pre-defined checklist.
There are a number of factors to consider when establishing IR35 status and very few of these will determine the outcome on their own. Ultimately however, in order for a contract to be considered outside IR35 it must demonstrate that it is one business providing a service to another business, and not an employee and employer relationship.
There are however, three key tests which are considered most important:
- Personal Services
- Is the service being provided a personal one or is it a genuine business to business service?
- Can the company providing the service provide a substitute to perform the contractual duties as any other business would be able to?
- To what extent does the company control the services carried out by the worker, if at all?
- Does the work fall under the direct control of the client or is the worker able to dictate how the work is carried out?
- Mutuality of Obligation
- Is there an obligation for the company to provide consistent and paid work and is the worker obliged to accept this work?
Additional factors to consider:
Beyond this, there are a number of other factors to consider when determining the status and whether IR35 does apply:
- Does the company performing the work hold their own business insurance?
- Would they be liable for rectifying any errors or unsatisfactory work at their own time and cost?
- Does the company providing the work manage other contracts at the same time?
- Are they limited contractually from performing work for other clients?
- Do they provide their own equipment?
- Is this equipment necessary for the job in hand?
Part and Parcel
- Are they part and parcel or the company’s organisation (an integral and essential piece)?
- Do they hold a contractor ID badge?
- Whose company name is outlined in their email signature?
- Do they employ on employee lists/organograms?
- Do they have their own business cards?
- Do they benefit from any employee benefits, such as holiday and sickness pay?
Additional factors can be assessed when establishing the workers status as part of the review. For example, a contract which is in place with a clear start and end date would favour more towards an Outside IR35 status, whereas a rolling contract would swing more towards an Inside IR35 status.
How is the status for IR35 assessed?
There are two main ways of a company assessing an individual’s IR35 status:
- HMRC’s IR35 tool – Check Employment Status for Tax (CEST)
HMRC introduced CEST ahead of the public sector IR35 reform in 2017 and it was built to determine the status of the contractors they engage. However, even by HMRC’s admission, it is seen as a work in progress and it has received some criticism, such as it not aligning to full case law and determining assessment based on just 16 questions. Therefore it does currently lack some trust from contractors and companies.
- Independent IR35 assessment services
An independent company employed to provide assessment for clients based on evidence provided.
Challenging an IR35 assessment
If the worker doesn’t agree with a status determination, they are able to appeal via a client-led disagreement process (not an independent service). The client has 45 days to respond. They can either change the determination and provide a new statement, or stand by their original decision with an explanation.
Ultimately there will be a period of adjustment throughout this process and certain areas, such as IT where contracting is in such high proportion, will be impacted far more than others. Similarly companies are taking a variety of approaches when dealing with their contracting workforce as they look to align themselves to fall comfortably within its remit.