What is happening and when?.
A clients guide to IR35 new legislation
HMRC introduced IR35 (or the ‘off-payroll working rules’) in 2000 to tackle what they call ‘disguised’ employment. Some contractors (and their hirers) might try to take advantage of the tax efficiency of working through a limited company, when in practice the contractor is essentially working as an employee.
IR35 is designed to assess whether a contractor is a genuine contractor rather than a ‘disguised’ employee, for the purposes of paying tax. Contractors who work through their limited company enjoy a level of tax efficiency. While they don’t get employee benefits (like holiday and sick pay), they have flexibility and control over their work.
The benefit for employers hiring workers in this way is that they don’t have to pay employers’ National Insurance contributions or give contractors employee benefits. The benefit for contractors is tax efficiency.
So, IR35 assesses whether contractors are for all intents and purposes employees when they take on work for clients.
Many find the legislation complicated to understand. Even HMRC seem to struggle – their record on successfully fighting IR35 cases at tribunal is patchy. This lack of clarity, along with ambiguity over employment status guidelines (including the available employment rights if contractors are found within IR35), has proven controversial since the law’s introduction.
IR35 rules for limited companies!
HMRC say that when determining whether IR35 applies to a contract or engagement, “you must work out the employment status of the person providing their services.” HMRC go on to say that the off-payroll rules apply if the contractor “would be an employee if there was no intermediary”. The intermediary in most cases is the contractor’s limited company (often called a personal service company).
HMRC also have a tool you can use to check whether IR35 applies to a contract (CEST, or the ‘check employment status for tax’ tool), plus an IR35 helpline. In reality IR35 status hinges on IR35 case law and employment legislation, itself reliant on decades worth of employment tests heard in the UK courts.
Another problem is that HMRC’s CEST tool may not be entirely accurate, as it doesn’t take a key piece of case law (mutuality of obligation, or MOO) into account.
Public sector and private sector rules…
There are currently different rules for public sector and private sector contracts.
- for public sector contracts – the hirer is responsible for working out whether the contractor falls inside or outside of IR35. If they fall inside, the hirer, agency or other third party who pays the contractor then needs to deduct tax and NICs and report them to HMRC
- for private sector contracts – the contractor is responsible for working out whether they fall inside or outside of IR35. If they’re inside, they need to pay the tax and NICs due
Private sector IR35 reform is set for April 2020, when the public sector rules will be applied to the private sector. This means private sector employers hiring contractors will be responsible for determining their IR35 status. Businesses and contractors should start preparing for this change as soon as possible.
IR35 checklist: are you compliant?
If you’re a contractor working out whether IR35 applies to a contract, there are a few principles to consider as part of a checklist.In general, IR35 won’t apply if the contract is for services rather than employment. To untangle that, you should see whether the contract specifically mentions these principles:
- supervision, direction, control – this relates to how much say your client has over how you complete your work. For example, if you have to work at certain times, this implies employment
- substitution – could you bring someone else in to complete the contract, or do you need to do the work yourself? If you can’t send someone else, you’re likely to be within IR35
- mutuality of obligation (MOO) – is there an obligation on the employer’s end to offer work, and do you have to accept it? This is called mutuality of obligation, and if it exists, the contract will fall within IR35
Supervision, direction, control
For a contract to fall outside of IR35, contractors should have freedom over how they complete their work. A contract that specifies things like the time you can start and finish work, or the days you’re required to work, is one that points towards employment. Other elements of an employment contract that HMRC look out for include a client overseeing your work excessively, and giving guidance on how to complete it.
Plus, if you’re not only providing your services for the agreed job but also working on different tasks as your client sees fit, the contract is likely to be within IR35.
Does your client only want you? For a contract to fall outside of IR35, you should be able to send a substitute to complete the work instead.This means the contract should state that someone else can provide their services to complete the work. The clause has to be genuine – you should know which skilled contractors you would ask, plus the contract can’t be so restrictive that you essentially need to do the work yourself.
Mutuality of obligation (MOO)
This is an important clause to include in a contract, as it’s a key test when determining self-employed status.
If the client is obliged to offer work (and pay you) and you’re obliged to take it, this demonstrates a contract of employment. In practice, a self-employed contract means working on a project-by-project basis. Once you’ve completed a project, you’re under no obligation to work on further tasks (and the client is under no obligation to offer them).
You should also consider whether you can work for other clients simultaneously. If a client and contract prohibits that, it points towards you being an employee rather than self-employed.
Other factors on your IR35 checklist
There’s more criteria to consider when determining your IR35 status:
- equipment – HMRC often try to argue that if equipment is provided by the client, and you don’t use your own, you’re a disguised employee
- financial risk – self-employed contractors usually take a degree of financial risk, like any business would. Are you responsible for errors made during the contract, and would you need to rectify them in your own time? There’s usually a requirement to have professional indemnity insurance
- the way you’re paid – self-employed people are paid on a project basis, which might mean when the work is completed or at particular project milestones
- ‘part and parcel’ of the organisation – if contractors become so ingrained that they become part of a company’s structure, with people reporting to them for example, this points to employment rather than self-employment
- exclusivity – do you work for other clients? Typically the self-employed can work for multiple clients at once
- intentions of the parties – the contract should make sure the relationship between contractor and client is one of supplier and customer, but this should be genuine. If HMRC found the actual intended relationship is more like an employee and employer, they’ll ignore the contract
- business ‘on your own account’ – essentially this determines whether you’re actually running your business as a business. If you have things like a business website, a dedicated office space, and even employees, you could be seen as operating a business and not offering your services in the same way as an employee
Make sure you clarify your relationship with the hirer before you start the contract by considering all of these principles. Again, before you start working, you should seek expert IR35 advice.
Small companies exemption – small companies will be exempt from the changes. A small company is one which meets two or more of the following criteria (a) annual turnover of not more than £10.2 million, (b) balance sheet total of not more than £5.1 million or (c) no more than 50 employees. Companies ingroups and joint ventures will be exempt provided all of the group companies or joint venture partnersare small. Unincorporated organisations with a turnover of less than £10.2 million will also be exempt.
Where organisations are exempt, the existing IR35 rules (where the intermediary is responsible for applying the rules) will continue to apply. When an organisation becomes or ceases to be small in an accounting period, for the purposes of the off-payroll rules that change will apply from the start of the tax year following the end of that accounting period, irrespective of whether the organisation is incorporated or unincorporated.
If a client does not take reasonable care in making its decision it will be liable for unpaid tax and national insurance. Agencies should make not tax status decisions for the clients. If a client does not have internal expertise to make these decisions, they could use an established IR35 external reviewer to help them. Be wary of contract reviewers who say they can “get an assignment outside IR35” simply by adding an unrestricted substitution clause to a contract. Courts look at the reality of the engagement rather than just the contractual documentation. An ability to substitute by itself will not get an assignment outside IR35 if all other circumstances point to inside IR35. From 6 April 2020 the off-payroll rules will apply to all public authorities, medium and large companies and organisations with a turnover of more than £10.2 million.
Passing status decisions through the supply chain – having made the tax status decision, the client will have to pass that decision, together with the reasons for that decision to both the party they contract with (usually the recruitment business) and the contractor (including where the client does not have a contract with the contractor). Each party has to pass the decision down until it reaches the fee-payer i.e. the party next to the intermediary in the supply chain. Resolving disagreements over status – the end user client must set up a client-led status disagreement process to help resolve disagreements about the status decision reached.
The client must respond within 45 days of receiving a query and must:(a)confirm that it has considered the representations made and decided that its SDS is correct, and give thereasons for that decision; or(b) give a new SDS containing a different conclusion and state that the previous SDS is withdrawn. If the client does not respond within 45 days it will become the fee-payer. REC advises its agency members not to substitute its own or a contractor’s view on status where this conflicts with the client’s decision. Liability – the proposals are that where the fee-payer is off-shore its responsibilities move up the supply chain to the next UK based entity.
It is also proposed that liability should rest with a party that has failed to fulfil its obligations until such time as it does meet its obligations at which point liability moves down the chain. However if HMRC are unable to collect the outstanding tax liability from a party, the consultation proposes that the liability should transfer back to the first party or agency in the chain, and if that fails, then HMRC will pursue the client. It is not appropriate for a client to ask an agency to indemnify it if the client does not do what it is required to do under the legislation.
Clients should start to prepare now for what is a fundamental change in the tax rules affecting how they engage with contractors.
1. Assess whether they will be affected or exempt from the off-payroll rules, because they are a smallcompany (or not) and should record this assessment. If exempt, tell their agencies, explaining why.
2. Assess who amongst their contractor population might be affected by these changes and why.REC recommends that clients assess all roles filled by contractors, and not just those it identifies arefilled on a given day by contractors working through their own personal services companies.
3. Identify who within their organisation can make IR35 status decisions and ensure that thoseindividuals understand how to assess status and have the appropriate tools to do so. If there isn’t aninternal person to do IR35 status decisions, then engage a well-established external reviewer.
4. Put processes in place to pass down the status decision and the reasons for that decision.
5. Work with agencies who will have their own processes to implement.
6. Agree with agencies how the increased employer costs will be met – agencies will not be able to simply absorb these costs and pay contractors the same.