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IR35: What do the new rules mean and am I affected?
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What is IR35?
IR35 is a piece of anti-avoidance tax legislation which is designed to ensure that those in ‘disguised employment’ pay the same rate of tax as those who are conventionally employed. The scheme is mainly targeted at contractors who HMRC view as ‘deemed employees’ rather than genuine contractors.
IR35, also known as ‘intermediaries’ legislation’ refers to the anti-avoidance tax legislation designed to tax disguised employment at a rate similar to employment. This measure tackles employees who work through an intermediary, such as a personal service company on a self-employed basis to take advantage of the tax benefits. If the limited company is removed and the nature of the work matches that of an employee, the individual in question would be classed as a ‘disguised employee’ and therefore caught by IR35.
The legislative measure which aims to reduce tax avoidance was established in 1999 and enforced in 2000 as part of the Finance Act. It essentially intends to eliminate employees attending work on a Friday and returning to work on the Monday as self-employed to avoid fulfilling tax obligations.
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The Treasury claims that non-compliance of IR35 has resulted in a significant tax loss and as a result, the legal regulations governing IR35 in the public sector have recently been subject to reform. From April 2021, if a PSC contractor works on a private sector contract for a medium-to-large business, the private sector body will be responsible for determining IR35 status – not the contractor. This measure has been hit with criticism due to the difficulty in determining IR35 status and the challenging nature of enforcing it. The measure was originally pencilled in for April 2020, however, following the COVID-19 pandemic, it has been delayed to April 2021.
As a result of this change, contractors directly affected may change the way they operate in order to maximise take-home pay.
The financial impact of being caught by IR35 requires you to pay Income Tax and make National Insurance Contributions (NIC). The legislative measure has proved controversial as it establishes a similar tax treatment to employees but without the employment rights and benefits. If you are found to be inside IR35, your take-home pay could be significantly reduced in comparison to when outside IR35.
As the hiring body, if you take on a contractor who is outside IR35, you will not pay Employers’ NIC on their behalf or be legally required to provide any employment benefits or rights, such as sick pay, holiday pay or maternity pay. If they fall inside IR35, you will be required to pay Employers’ NIC, but you will not be legally obliged to provide employment rights.
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IR35 status is typically determined by three key factors; control, mutuality of obligation and right to substitution.
Control: An employee is typically directed and supervised by the employer, however, a contractor should have the freedom and flexibility to determine how the task will be completed and the manner in which this will be performed
Mutuality of obligation: Mutuality of obligation refers to expectations which are in place for the contractor at the end of the contract. An employee would typically have a constant workload, whereas a contractor would only be required to complete the contracted task. If the contractor is expected to complete ongoing work after the contract has ended, similar to an employee, this falls in line with traditional employment.
Right to substitution: The contractor must have the right to provide a substitute worker in the event that they are unavailable or unable to complete the contract. The contractor should have the ability to select and train a suitable substitute and the client should reasonably accept the substitute. By incorporating the right to substitution into a contract, this will reduce your chances of being penalised in the event of an IR35 investigation.
If a contract is in place between the client and agency, agency and contractor, the above factors of Control, Mutuality of Obligation and Right to Substitution should be inherent in both contracts.
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In addition to the above factors, the following will also be taken into consideration by HMRC:
- Own accord: Contractors should carry out the contract voluntarily and based on their own decision
- Equipment: The contractor has the choice to use their own equipment and is not obliged to use the client’s equipment.
- Employer/Employee relationship: The contractor should not become dependent on the employer and become an integral part of the organisation, such as participating in staff social events and team meetings which reflects the same behaviour of an employee
- Exclusivity: Contractors typically work for more than one client at any given time, so the service is not exclusive
In the event of an IR35 investigation, HMRC will judge you on the above factors to ensure that you are not a disguised employee in order to minimise your tax liabilities.
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HMRC developed the ‘check for employment status’ (CEST) tool to determine whether you are employed or self-employed, reflecting if you are inside IR35 or outside IR35. The decision will be based on the nature of each contract including your responsibilities, so if this changes, you will be required to review your employment status. Following the IR35 reform in the public sector, employers are also required to use the CEST tool or an independent IR35 tool to determine the IR35 liability of contractors.
It is important to note that IR35 public sector and IR35 private sector rules vary following the recent changes announced by HMRC. The change in IR35 rules can affect the manner in which contractors operate, such as through a limited company or umbrella company. As a result, an alternative structure may reflect a better a take-home pay following the enforcement of the private sector reform in 2021.
If you are seeking to close your limited company as a result of changing IR35 legislation, we urge you to consider a solvent liquidation which is cost-efficient, such as a Members’ Voluntary Liquidation (MVL). Contact one of our licensed insolvency practitioners at an office near you if your limited company will be affected by the IR35 private sector reform in 2021.
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