Heads up for IR35 tax changes
Why does IR35 matter?
IR35 was introduced in 2000 to ensure that contractors who work in a similar manner to employees pay a similar rate of tax and national insurance.
Contractors often supply their services to the end user via a professional service company (PSC). This can either be through their own limited company or an agency. Prior to 2000, artificially adding a PSC between the contractor and the end user allowed individuals to reduce their tax burden by changing their relationship from one of employee and employer to contractor and end user. It is this artificiality which HMRC seeks to challenge with IR35.
What is IR35?
The test for whether IR35 will apply or not, is a deliberately simplistic one. IR35 will apply in circumstances where:
1. An individual personally performs services for a client;
2. Those services are provided under arrangements involving an intermediary such as a PSC;
3. The circumstances are such that if the arrangements had been made directly between the individual and the client, the individual would have been regarded as employed by the client for tax and national insurance contributions.
The third criterion is often referred to as the 'employment test'. HMRC has provided guidance on the factors that it considers to be most important in determining an individual's employment status:
- Personal service. In order for the contractor to be an employee, they must be obliged to provide their services personally. If they are able to provide a substitute to do the work, this may point away from an employment relationship;
- Mutuality of obligation. There must be an obligation on the part of the contactor to provide their work and the end-user to pay for that service. Where someone is genuinely employed they will be obliged to work and they will expect to be paid. Those who are self-employed often cannot expect regular work.
- Control. To be an employee there must be a degree of control over them, for example the way they perform their services.
- Equipment. Someone self-employed would be expected to provide their own equipment.
- Financial risk. Those who incur or risk their own money are likely to be self-employed. Employees do not have the same financial risk, they will expect to get paid every month and will be reimbursed for expenses.
- Integration. If a contractor is integrated into the organisation they are more likely to be an employee.
How does IR35 affect me?
Currently it is the responsibility of the PSC to apply the above test. The PSC has to decide if the individual supplying the services to the end user is caught by IR35, in particular the employment test, and determine whether the individual would actually be an employee were it not for the presence of the PSC. The PSC has an incentive to determine that it is not caught by IR35. Not only that, but given the significant number of small organisations to review, HMRC have historically been unable to effectively review all of them.
From 6 April 2021, the responsibility to determine whether IR35 applies will shift from the PSC to the end user. The onus will be on organisations who contract with PSCs to assess whether the individuals provided to them are working in a manner akin to an employee. If so, the taxation consequences can be significant:
- For the individual providing the services, they will now be subject to the full tax and NICs as if they were an employee;
- For the end user, they will face an increased administration burden as well as potentially having to pay the additional cost of employer National Insurance Contributions (at 13.8%).
Not all end users will have to apply IR35. There is an important exemption for "small companies", defined as businesses which satisfy at least two of the below requirements:
- An annual turnover of 10.2m or less;
- A balance sheet of £5.1m or less;
- 50 employees or less.
What can I do to prepare?
Whilst these changes are still a couple of months away we would recommend that organisations start their preparations now by:
• reviewing which PSCs are engaged (including those sourced via agencies) and assess whether the reality of the engagement may be more akin to an employment relationship
• using HMRC's online status guidance tool (CEST) which is a good starting point as part of the employment status assessment process
• reviewing the contracts you have with the contractors you engage, or implement a contract if one isn’t in place to govern the relationship. This contract should set out the relationship to reduce the risk of IR35 applying but the provisions must accurately reflect the reality of the contractual relationship
• taking independent professional advice on whether IR35 applies to the contractors you engage and the practical steps that you will need to take to meet your obligations under the new rules.