What is IR35?
IR35 (sometimes known as “off-payroll working”) applies where an individual personally provides their services to a client through an intermediary company, usually a personal service company (PSC) which is a limited company that they own, and if it was not for the PSC, the individual would be an employee or office-holder (e.g. director) of the client.
For those who fall inside IR35 deductions for tax and NI must be made from their pay/fees as if they were an employee.
The idea behind IR35 was to ‘clamp down’ on a perceived form of tax avoidance, whereby an individual who would have normally been an employee for the purposes of NI and tax contributions, instead contracted out their services through a PSC and paid themselves by way of a dividend (which are not subject to tax and NI) instead of on a PAYE basis. Such arrangements are common in industries such as financial services, IT and various fields within the engineering sector.
Since April 2000, contractors have been responsible for self-assessing their IR35 status and National Insurance contributions. However, this arrangement has been ineffective and so new IR35 legislation is to be introduced in April 2020 that shifts responsibility for assessing IR35 from the PSC to the end-client, i.e. the company that uses the contractors. Similar rules were introduced in the public sector in 2017.
Who is affected by the new rules?
The new rules will apply to:
- Individuals supplying their services through an intermediary, such as a PSC, and who would be employed if engaged directly.
- Medium and large-sized organisations in the private sector that engage with individuals through PSCs.
- Agencies and other intermediaries supplying staff through PSCs.
Where the end-client is a small business, the PSC will continue to be responsible for assessing whether IR35 applies. In the case of a company, LLP, unregistered company or overseas company, a small business is an organisation with two or more of the following: an annual turnover of £10.2m or less; a balance sheet total of £5.1m or less and/or 50 employees or fewer.
How do the new rules differ from the current IR35 system?
With effect from 6 April 2020, the end-client, rather than the PSC, will be responsible for determining whether the IR35 rules apply.
If the end-client decides that the contractor is inside IR35the person paying the PSC (“fee payer”) will be responsible for deducting income tax and employee NICs and accounting for employer NICs. The employer NICs in respect of the fees paid to the PSC are also taken into account in determining the fee payer’s liability for the Apprenticeship Levy. If the end-client decides that the contractor is outside IR35the fee payer will continue to pay the PSC gross. Depending on the nature of the relationship, it is possible for the end-client and fee payer to be the same entity.
In advance of the first payment being made, the end-client must inform both the entity with which they contract (e.g. an agency) and the contractor of their determination and the reasons for it.
It may be the case that some agencies will agree to carry out the determinations for their end-clients in order to save the end-client the time and cost involved in doing so, particularly as the agency will likely have more information about the contractor. Where this occurs, consideration will have to be given as to how the parties will share information, who will be ultimately responsible for determinations and how the process will work and we suggest specialist advice is taken in this regard.
How is the determination regarding IR35 made?
In assessing whether a contractor is inside IR35, end-clients need to apply the normal employment status tests. These include considering: whether the contractor is subject to control; has a right of substitution; is integrated into the client’s business or carrying on business on their own account; and whether there is mutuality of obligation between the parties. This should be done prior to the start of each and every engagement – a blanket determination will not be acceptable.
HMRC has an online tool “Check Employment Status for Tax (CEST) to assist with this. Using CEST is not mandatory but it has the advantage of a result that is binding on HMRC provided that information has been correctly inputted into CEST. That said, CEST has received some criticism regarding accuracy. The Government has committed to improving CEST and offering further support. However, end-clients are advised to ensure that they have their own system in place for assessing employment status in addition to using CEST.
Further, under the new rules there is to be a “client-led status determination process”. This is effectively an appeal process whereby the contractor can challenge a determination and the end-client must reconsider and issue a response, with reasons, within 45 days. The contractor can thereafter appeal to HMRC. End-clients should, therefore, draft a determination process outlining how contractors can challenge a determination.
Liability
If the end-client fails to make the IR35 determination on time, fails to tell the party it contracts with and/or the contractor the determination or fails to take reasonable care in making it, the liability to deduct PAYE and NICs remains with the end-client notwithstanding the existence of a separate fee payer.
Employment status -unexpected consequences?
The IR35 rules only apply for tax/NIC purposes and do not affect the contractor’s status for employment law purposes. However, the tests are very similar. Therefore, we may see an increase in challenge to employment status where a self-employed contractor is held to be inside IR35 as the tax advantage of not being a worker/employee will have been removed.
Where a contractor is considered to be a worker or employee for employment law purposes, they would be entitled to the same rights, e.g. holidays, sick pay and, in the case of employees, the right not to be unfairly dismissed. This is, therefore, an issue companies engaging contractors need to be alive to and they are advised to take legal advice regarding what steps can be taken to minimise the argument that a contractor is a worker or employee.
IR35 Seminar
Would you be interested in attending a seminar on this topic? In advance of this new legislation coming into place, we intend to offer a free seminar for those employers who engage contractors. If you would be interested in attending a seminar on this topic, please email events@thorntons-law.co.uk stating which location you would like to attend: Dundee, Perth, Glasgow, Edinburgh, Angus or Fife.
Amy Jones is a specialist Employment Solicitor. If you need Employment advice please contact Amy on 01382 229111 or email ajones@thorntons-law.co.uk or alternatively contact a member of the Employment Law team.
