Updated: 9th February 2021
IR35 is also known as the Intermediaries Legislation, and originally came into force in April 2000 in an attempt by the government to prevent tax avoidance. It was based around the premise that independent contractors were able to avoid tax payments by working through an intermediary such as their own limited company, rather than as employees under the PAYE scheme.
Others worked via recruitment agencies or umbrella companies which deal with salary and tax payments. Employment status was deemed questionable by HMRC in some cases – where a lengthy contract had been agreed, for example, or when HMRC considered contractors as ‘disguised employees.’
When an employee leaves work as an employee on a Friday and returns as a contractor on the Monday, carrying out the same work but no longer paying as much tax, this has become known as ‘disguised employment.’
The practice also benefits the former employer who no longer has to make Employers’ National Insurance contributions, or make available any employment benefits or rights to the contractor.
IR35 legislation aimed to identify disguised employees by introducing a test for employment status. If a contractor fails this test, they may fall ‘inside IR35’ and have to pay tax and National Insurance contributions as if they were an employee.
Although HMRC have recently introduced a new tool to determine employment status, various aspects of a contract can indicate whether a contractor is employed or self-employed, including:
Other areas to consider include whether or not you provide the equipment to carry out the contract, for example computer or video editing hardware, the level of financial risk you take on, and the ‘length of engagement.’
To be viewed as self-employed, you should also avoid being seen as ‘part and parcel’ of your client’s firm. This means not entering the building using a security pass along with your client’s employees – even using the staff canteen could be held against you during an IR35 tax investigation.
To summarise, it is an overall view of your working practices that is tested for IR35. For example, if a contract states the personal service company can send another person in your place to carry out the work, this proves you have the ‘right of substitution’ and when all other factors are taken into account, it could mean that IR35 does not apply.
The government cite a combination of complex IR35 rules that are difficult to understand, and extensive non-compliance costing a purported £440 million every year¹ as the reasons for changing IR35 legislation in the 2017 Budget.
HMRC believe there are many cases where, if it wasn’t for the existence of a limited company, i.e. a personal service company that acts as intermediary, directors would be classed as an employee of their client.
Historically, the responsibility for deciding whether IR35 rules apply and for paying the correct amount of tax, lay with the contractor. In April this year, for those working in the public sector only, responsibility for applying IR35 rules shifts to the end-client.
Many grey areas exist when deciding whether IR35 applies, however. The new online Employment Status Service Tool provided by HMRC asks questions regarding various aspects of a contract, such as whether there is a right of substitution, and the public sector client has 31 days in which to determine a contractor’s employment status.
This new process presents a danger to company directors running their own personal service company, as there may be a natural inclination by the public bodies to deem contractors as ‘within IR35’ in order to avoid making the wrong decision.
Apart from the significant loss of earnings for company directors caught by IR35, it is feared that, in turn, this could trigger an IR35 tax investigation by HMRC into previous contracts going back many years.
So what happens when a contractor is deemed to be ‘inside IR35’ and subject to the legislation? HMRC will look at each contract, deduct the tax that has been paid from what an employee would have paid through PAYE, and backdate this tax charge to the contractor.
This process can cause severe financial hardship in many cases, and easily result in insolvency for the personal service company involved. HMRC have the power to look back at contracts for at least six years to see if contractors/company directors fall within IR35 rules.
The potential for reduced income on a long-term basis, particularly for personal service companies whose clients are predominantly in the public sector, is worrying indeed. But if HMRC also apply IR35 to previous contracts already completed, this combination could cause a spiral into debt that is hard to escape.
Even if you feel certain that IR35 does not apply to your own working situation, HMRC can still launch an investigation, causing disruption and expense. Intermediaries Legislation is an extremely complex area, and requires the input of an IR35 specialist to pre-empt tax investigations, and help you deal with them should you be targeted.
Real Business Rescue will help if you are unsure whether IR35 rules apply, or are facing scrutiny by HMRC. We can advise you on the new ‘off-payroll’ IR35 regulations, and obtain clarity on a particularly complex area of self-employment. Call our experts to arrange a same-day meeting at one of our offices.
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