What is IR35?
IR35 legislation came into place in April 2000 and is designed to combat tax evasion by determining if a contractor working through an intermediary, such as a personal service company or agency, is in fact an employee from a tax treatment perspective. As a contractor a worker can pay themselves via a combination of salary and dividends without the tax ramifications associated with being an employee and many workers were taking advantage of this loophole. So what is IR35?
HMRC categorises such workers as ‘disguised employees’ under IR35 legislation. ‘Disguised employees’ are those who HMRC do not class as self-employed – i.e. they would normally be an employee if the intermediary was not in place.
When contractors are found to be ‘disguised employees’ they are classed as falling ‘inside IR35’ and will be forced to make PAYE and NIC payments. However, a point of contention for contractors is that whilst they are treated the same as an employee from a tax perspective, they receive none of the employment rights that they believe should accompany ‘deemed employee’ status.
How to determine your IR35 position
As a contractor, you will need to make sure you are IR35 compliant. It is important to determine if you fall inside or outside of IR35 at the start of each contract.
There are many grey areas and legislation is complex when it comes to IR35. It is therefore recommended that you always consult an expert on your position. The cost of non-compliance can lead to substantial costs in back taxes, fines and penalties – not to mention the decrease in net income moving forward. In practice IR35 is very complex and it is easy to get it wrong with serious consequences.
In an enquiry HMRC will look initially at the wording of a worker’s contract with an agency and end customer and then put greater emphasis on the actual working practices. There are a few questions that can be considered when looking at whether a contract is IR35 compliant.
Among them are:
How much autonomy and control does the customer have? A true contractor tends to have more influence on how they work for the customer. True IR35-friendly contracts should also contain a substitution clause whereby they offer the service of a business rather than that of an individual.
Is there a mutuality of obligation? This means the end customer is obliged to offer work and the worker is required to accept and undertake it. Truly self-employed workers will have no mutuality of obligation and once the task is completed there will be no expectation of further work. Questions can arise when contracts are continually renewed, or notice is required to terminate a contract.
You can also look at aspects such as whether equipment is provided by the customer or the contractor, and whether most of the financial risk is with the customer and not the self-employed.
HMRC have developed a Check Employment Status for Tax tool (CEST) which can be used to help determine your IR35 status, but some of this information is ambiguous. You should remember that each contract you engage in will need to be assessed as you may find you have some that fall inside and some that fall outside of IR35.
Public sector reform changes
In 2017, changes to IR35 in the public sector saw the compliance burden shifting from the contractor’s limited company and expanding to their customers and agencies. The result of such changes has meant that many organisations were left unprepared and blanket decisions on IR35 became commonplace, resulting in many contractors being overtaxed.
Private sector reform changes
The anticipated expansion of the same changes to IR35 in the private sector could cause difficulties for organisations that engage contractors.
HMRC has issued a consultation on implementation of reforms to the off-payroll working rules, which will be extended to the private sector from April 2020. The consultation provides useful detail on the intended scope of the reforms – which will impact both private and public sector organisations – and is intended to help businesses start preparing for reform. Draft legislation will be published this summer.
The consultation proposes new rules to deal with employment status disagreements which would apply to both private and public sector organisations.
The reforms will come into effect from 6 April 2020. Due to the complexity of many private sector companies, and the number of stakeholders involved in the required system and process changes, businesses should start preparing now. In many cases it can take up to 18 months to implement an effective strategy addressing cost, risk and talent management considerations.
As a result of the impending reforms it is important that employers in the private sector review and mitigate the IR35 risk that their working practices pose. There is a high probability that contractors will increase their rates to counter their losses or seek work elsewhere if deemed caught by IR35.
If you are worried by IR35 and have any questions relating to whether your contract falls inside or outside of IR35, contact our IR35 specialist tax accountants. We can ensure you are compliant and advise on the most advantageous route for your business as well as preparing any private sector organisations for the anticipated reforms.