Everything you need to know about IR35
Here's our complete guide to IR35 - who it affects, who it doesn't, and how to prepare clients for it
Here's our complete guide to IR35 - who it affects, who it doesn't, and how to prepare clients for it
If you are self-employed, or you run a business hiring contractors, you will probably have heard about IR35. It’s the legislation in place to make sure contractors pay the right amount of tax and national insurance and it was first introduced by HM Revenue & Customs (HMRC) in 2000.
It is designed to stop workers using an intermediary, such as a limited company, to pay less tax, when they should instead by employed directly by the client they are working for and treated as an employee.
These workers are known as ‘disguised employers’ by HMRC and if someone is caught working in this way, they will be asked to pay the tax and national insurance due as if they were an employee, which can mean they end up with a significantly bigger tax bill.
However, there is a lot of confusion over how IR35 works and who it applies to. Here we explain exactly what the legislation means, the difference between private and public sector workers when it comes to IR35, and its main criticisms.
The Government defines IR35 as ‘off-payroll working through an intermediary’. It applies to some contractors who produce work for a client through their own intermediary.
Working through an intermediary can mean the contractor pays tax and national insurance in a different way to employees. The law around IR35 is in place to make sure if a worker would have been seen as an employee, they pay the same tax and national insurance as someone who is an employee.
It came into law on 6 April 2000 and reforms to IR35 were introduced in April 2017 for those working in the public sector. The Chancellor, Philip Hammond, confirmed these would be extended to the private sector in the Autumn Budget in 2018 yet confirmation of how this would work and when it would happen has been delayed until 2020.
Contractors who use intermediary services but would be employees if they were providing their services directly to a company are affected by IR35.
The intermediary used could be a limited company, a personal service company (PSC), a partnership or another individual. In order to prove someone is outside of IR35, a contractor in the private sector needs to show there is no employment relationship (in the public sector it’s up to the employer to prove this).
This is done by looking at who controls the work being carried out, if the contractor can send a substitute in their place, and if the client is obliged to provide work, or if the contractor is obliged to accept it.
HMRC has a tool for employers called the Check Employment Status for Tax (CEST) which was introduced with the reforms to IR35 in 2017. This can help to determine whether someone working falls inside IR35 or not.
When determining if someone falls inside or outside IR35, there are some general factors to look at which include:
An example of someone falling within the IR35 rules would be a contractor, working on site for a firm carrying out highly skilled design work with computers and software provided by the client, who has to request time off during a 12-month period.
While an IT contractor working for a firm on a one-off project which is due to take three months, using their own equipment, working from home, and being paid a fixed amount for that work, would usually be seen as outside IR35.
To find out exactly how much more a self-employed person would pay who falls under IR35 there are lots of online calculators available, such as this one from Contractcalulator.co.uk, but you can also seek professional advice.
Reforms for IR35 were introduced for workers in the public sector in 2017, but the roll-out for the private sector is not expected until April 2020.
This means public authorities are responsible for deciding if IR35 applies to workers while at the moment in the private sector it’s up to the contractor to decide this.
The worker needs to let the public authority know they are working through an intermediary and give certain information to them in order for them to make the decision.
If a worker is deemed as being inside IR35 there are several things the public authority needs to do and these include:
The authority needs to work out a ‘deemed payment’ for the worker – which is basically how much they will end up getting paid, minus any taxes.
When calculating the payment there are a few things the authority needs to take into consideration. These include taking off any VAT due, the costs of materials used by the worker in order for them to deliver the service, expenses they will have to pay that would have been deductible from taxable earnings if they were employed, plus national insurance contributions.
The authority will need to report the payment to HMRC through a Full Payment Submission (FPS), in a similar way to how they already work with existing employees.
The authority can add the worker to their payroll system if they want to and if the payments aren’t reported under an existing PAYEscheme, a new one will need to be opened.
As soon as a worker is added to a payroll system a new starter declaration needs to be sent to HMRC. As the employee will be primarily employed by the intermediary, the contract being set up is usually for secondary employment. In these cases the employer needs to fill in the starter declaration C form and the employee will be set up with the tax code BR (you can find out exactly what kind of declaration is needed here).
Any workers who fall within IR35 need to be given a unique worker ID to show HMRC which is their primary and secondary employment.
Most self-employed workers are directors of their limited companies and carry out office-holder duties for them. However, if a worker undertakes office-holder duties within an organisation, their income from the employment needs to be taxed as employment income and this will be paid through the client’s FPS.
When the contract ends the authority needs to give the end date to HMRC, report any payments made after this date, and send a P45 to the worker.
There are a number of exceptions which need to be taken into account by public authorities. These are not relevant for workers who use intermediary companies and include; student loan payments which employees pay through their own tax return, statutory payments because the worker is not an employee, and workplace pensions.
When it comes to the private sector, HMRC said just 10 per cent of intermediaries apply existing legislation correctly and the cost of non-compliance is estimated to reach £1.3bn by 2023-24.
This is why reforms are being introduced but the roll-out have been delayed to 2020 and the Government has said the rules won’t include the 1.5 million smallest companies.
The reforms should echo what has happened in the public sector and shift the onus of deciding if an employee falls under IR35 or not to the employer not the employee.
However, as the private sector works differently to the public sector, several elements need to be ironed out first. These include the fact there may be a long supply chain of employers involved in a work project. HMRC has said it will make it law that a client passes on the status of the employee along the chain, but how this will happen and who will be liable if it doesn’t, or if it makes the wrong decision, isn’t clear yet.
Experts have been quick to criticise the reforms of IR35. Anthony Sherick, managing director of ContractorUK, says: “Bringing IR35 reforms to the private sector will have a negative impact on the UK economy.
“Contractors are crucial for plugging the widening IT skills gap, fuelling growth in the digital economy and delivering crucial projects. Should we see an exodus of contractors, UK businesses will struggle to fill workforce gaps and deliver key projects; ultimately negatively impacting the economy.”
Lee Murphy, founder of online accounting software Pandle, echoes this statement and slams the fact some workers will now earn a lot less.
He says: “Effectively contractors, especially highly skilled IT ones, will be forced to join ‘umbrella companies’ and pay more tax and national insurance.
“For instance, we calculate that a self-employed contractor currently earning £50,000 per year, will typically take home £43,670 after tax, national insurance and other costs. They will now be compelled to go through an umbrella company, meaning their take-home pay will reduce to £37,696 because of increased tax and national insurance costs.”
However, James Poyser chief executive officer of inniAccounts, counters this argument. He says: “Our nation’s incredible flexible workforce are responsible for delivering innovation and advancement that provide competitive advantage in spades. Because of this strong magnetism, companies will work hard to make off-payroll work.
“Yes, there’s going to be losers – there’s plenty of people out there who are kidding themselves if they think they’re outside IR35, but there’s plenty of people – the majority of the market – who are safely outside IR35, and for them April 2020 is business as usual.”
Accountants have also pointed to the fact there is no appeals process in place. They have suggested that if employers have to provide a worker and other members of a supply chain with a decision on an employee and make the wrong choice, they will then be liable for extra taxes and therefore they may incorrectly assign them as employees falling under IR35.
“Blanket responses such as these were seen in the public sector and produced some interesting headlines.
“The fallout from this may not yet have filtered its way through the system, as an appeal process does not really exist within the public sector rules and given that Individuals have only just filed tax returns for 2017/18,” comments Susan Ball, head of employer advisory services at the tax firm, Crowe UK.
A second consultation into IR35 was opened in March, after HMRC admitted some problems with the existing reforms.
Stakeholders are now being asked for their views on the IR35 reforms and how they will work in the private sector.
The consultation closes on May 28 and the initial results are expected to be published in the next Finance Bill which is due out in the summer. These should then be finalised later in the year.