IR35 is a tricky piece of legislation to get to grips with. And while compliance has previously been the responsibility of individuals working through a personal service company (PSC) or an intermediary, recent reforms are shifting responsibility onto the businesses engaging their services. This makes it crucial for employers to understand what the rules are and how to abide by them.
What is IR35?
IR35 is government legislation that entitles HMRC to collect tax and insurance from off-payroll workers, that is, workers operating via a PSC or an intermediary, instead of inclusion on the company’s payroll, even though their relationship with the organisation they are working for is almost exactly like that of an employee. For this reason, these types of workers, are also known as ’disguised employees’.
The legislation was introduced because the Government believed that some contractors were providing their services through a limited company or a partnership as a means of avoiding tax and national insurance contributions.
IR35 has been around since 2000, but the liability to pay tax and national insurance contributions fell with the PSC or intermediary and not the client they provide services to. However, only around 10% of PSCs and intermediaries were doing so.
To counteract this, the government has been shifting responsibility for IR35 compliance to the PSC’s clients. In 2017, this change was introduced in the public sector.
From 6 April 2021, these changes will also apply within the private sector, and it will be the client’s responsibility to determine whether IR35 rules apply for every individual working for them through a PSC or intermediary. They will also assume responsibility for paying employer National Insurance Contributions for off-payroll workers and ensuring that the correct income tax and National Insurance contributions are deducted from the fees paid to them.
The good news for smaller businesses is that these rules of responsibility will only apply to medium and large-sized business. A small business for this exemption is broadly one that has 2 or more of the following features:
- 50 employees or less
- an annual turnover of £10.2 million or less; and/or
- a balance sheet total of £5.1m or less.
How to tell if a contractor falls inside IR35?
So, how do you work out if IR35 rules apply to the contractors you work with?
Essentially, you need to determine whether their working relationship with you is closer in status to that of an employee.
This is not straightforward, but the following are factors to consider:
- Mutuality of obligation – this relates to the obligation on the part of the client to provide work, and the obligation on the part of the worker to accept. A genuinely self-employed individual will not be expected to carry out work, or be offered work, beyond that specifically agreed at the start of the contract.
- Right to substitution – this is to do with the individual actually carrying out the work personally. If you have employed the services of an intermediary, it is, in theory, a company, rather than a specific individual, delivering the work. If there is an expectation that the contractor working for you will undertake all the work themselves, this would be closer to an employer-employee relationship.
- Degree of control – how much freedom does the contractor have over their schedule, how they carry out the work they’ve been tasked to deliver, the hours they work and when they take holiday? Genuinely self-employed individuals will have considerable autonomy and freedom over when and how they perform the work.
How to prepare for IR35 changes in the private sector?
- Review the contracts of all individuals working for you through a PSC or an intermediary and determine whether any of the working relationships you hold with these individuals resembles that of an employer and employee. Where this is the case, it is likely that IR35 rules may apply, meaning you are responsible for deducting tax and national insurance from their pay.
- Consider the cost implications of paying employer national insurance contributions for any contractors falling within IR35. It’s possible that the increased financial burden on your business will be unsustainable and you will need to terminate certain contracts
- Apply caution. Taking a blanket approach and deducting tax from all intermediaries (an approach taken by many organisations in the public sector when the law change was introduced there) would disadvantage genuinely self-employed contractors, and deter them from working for you.
- Ensure your contractual agreements correctly define the working relationship and take care that these agreements go on to reflect the reality of the relationship, as it’s the working practices that will ultimately be considered in a tribunal.
What happens if you don’t comply with IR35 rules?
Failing to correctly determine whether IR35 rules apply could lead to financial penalties from HMRC.
It may also lead to disagreements where the worker wishes to provide services through the PSC as a contractor and does not want to work under a PAYE arrangement. This may in turn cause recruitment and resource issues and could damage any existing or future relationships if you incorrectly classify them as providing services within the IR35 regime.
Get HR Support
Need help reviewing contracts and working out whether the new IR35 rules apply to individuals working for you?
- What are the different types of employment contract and why are they important?
- Employee, contractor, worker – how to tell the difference?
- When does a contractor become an employee?
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