Whether you’re a contractor, an end client, or a recruitment agency, you need to know about the IR35 rules – specifically how they’ve changed and the resulting implications. If you don’t you risk non-compliance, and could face repercussions from HMRC.
In this blog, we outline what these tax rules are, their history, and how each party can comply with them.
Understanding the fundamentals
What is IR35?
Introduced in 2000, IR35 – also known as the ‘intermediaries legislation’ or ‘off-payroll working rules’ – is a UK tax legislation that aims to reduce ‘disguised employment’.
They were brought in because HMRC found some contractors to be working in the same way as a permanent employee, whilst receiving self-employment tax benefits. IR35 would crack down on this tax avoidance, and ensure those who weren’t genuinely self-employed would pay the same Income Tax and National Insurance Contributions (NICs) as an employee.
What are the off-payroll reforms?
The reforms are changes to how the legislation is applied. The key alteration was that the responsibility for determining IR35 was changed to the end client, rather than the contractor, in the majority of cases.
These reforms were introduced in the public sector in April 2017. In April 2021, after a 12-month delay due to the pandemic, they were extended to the private sector. We talk more about the changes and how they’ve impacted individual parties in the next section.
Have the IR35 rules changed in 2023?
Despite confusion created by the Budget announcements in 2022, there haven’t been any changes to the off-payroll working rules since 2021 – but that’s not to say they won’t change in the future.
In 2023 there was a consultation around the tax offset. If the legislation is passed, this would allow HMRC to account for taxes that have already been paid by a worker when calculating their PAYE liability due by the fee payer, where the off-payroll rules weren’t applied correctly.
Who do the IR35 rules apply to?
The off-payroll working rules can apply to the following three parties in the supply chain:
- A worker providing their services to a client via their own intermediary (this is generally a limited company, though this can also be a partnership or another individual).
- A client receiving these services (they can also be known as the ‘engager’ or ‘end client’).
- An agency or other supplier who provides the workers’ services through their intermediary.
How do the rules affect contractors?
Prior to the changes, contractors had to determine the IR35 status of their assignments. This was pre-April 2017 for public sector contracts, and pre-April 2021 for private sector engagements.
The liability was then shifted to the client in the public sector when the first set of reforms occurred. However, with the private sector reforms in 2021, the contractor is still responsible for determining status in some situations: if the engagement is with a company that’s wholly overseas or is defined as a small company (in accordance with the Companies Act 2006).
How do the rules affect clients?
Post-April 2017, the responsibility for determining an assignment’s status lies with public sector organisations. Private sector businesses weren’t impacted until April 2021. As this responsibility shifted, it also meant that if IR35 status had been incorrectly determined, the fee-payer would be responsible for the outstanding tax due.
The fee payer is the party paying the contractor and is the entity directly above the contractor’s limited company in the supply chain. This could be the end client if they contracted directly or, more commonly, a recruitment agency who will therefore become the fee payer.
How do the rules affect recruitment agencies?
Recruitment agencies placing a contractor into an end client could be the fee payer under the new off-payroll working rules. It’s the party closest to the worker in the supply chain who’ll be the fee-payer. As a result, recruitment agencies at the bottom of the supply chain will be held responsible for deducting and accounting for tax due.
Although the agency has no responsibility in terms of determining employment status for tax purposes, as the fee payer, they will be liable for tax owed should HMRC successfully challenge the IR35 status of an engagement. Given this financial risk, it’s a good idea for recruitment agencies to take out insurance. For example, our Off-Payroll Protect policy provides £100,000 of cover per contractor for professional fees to defend an IR35 status enquiry, and £100,000 of cover per contractor for tax and NICs liability, interest and penalties if an assignment is deemed inside IR35.
IR35 rules for contractors
What are the key status tests to determine IR35 status?
If the off-payroll working rules dictate that it’s the contractor who must assess if they’re an employee for tax purposes, HMRC would closely consider the relationship between the worker and the client – specifically, the contractual terms and working practices.
An assignment’s IR35 status revolves around these elements:
- Personal service: This includes the right of substitution, and if the worker has a right to provide a replacement to perform the service they’re carrying out.
- Mutuality of Obligation (MOO): In its purest form, this is when there’s an obligation for the client to give the contractor work, and the worker to do it. It’s a complicated factor, and to prove if the assignment is subject to it requires further consideration.
- Control: This is whether the contractor has autonomy over the services they provide – specifically in how and when they perform them.
Whilst these are the three key factors, there are many others at play. For example: whether there’s a financial risk for the contractor, if the worker is ‘part and parcel’ in the client’s organisation, and if they’ve been provided equipment to carry out the work.
IR35 is complicated, and you should be aware that these status tests are simply tests – not rules. They’re a way of helping to determine employment status for tax purposes. Each case is unique; to establish status the assessor needs the whole picture. Our IR35 Status Tool takes a hybrid approach to gain this.
What is meant by the term “disguised employees”?
‘Disguised employment’ or ‘disguised employees’ is used to describe contractors who operate through an intermediary (such as their own limited company) on a self-employed basis, but work in the same way as an employee.
If they’re found to be a disguised employee, although they can still run a limited company or Personal Service Company (PSC), they wouldn’t be deemed genuinely self-employed, so would be an employee for tax purposes.
IR35 rules for businesses working with contractors
What are end clients’ responsibilities for assessing IR35 status?
IR35 rules state that if the engagement is in the public sector and post-April 2017, the client is responsible for determining its status. Private sector businesses and organisations may also hold this responsibility to determine status if they’re a medium or large-sized business with a UK presence, and the engagement lapses into post-April 2021.
Following the assessment, the rules stipulate that they must send a Status Determination Statement (SDS) to inform contractors of their decision and the rationale behind it. They’ll also be the fee-payer if they engage the contractor directly (i.e. there’s no agency in the chain).
IR35 rules for recruitment agencies working with contractors
What are recruitment agencies’ responsibilities for assessing IR35 status?
An agency holds no responsibility for assessing status; the only responsibility they have is to pass on the SDS to the next party. Though, if they’re placing a contractor into a business, they may also become the fee-payer.
What’s the difference between an ‘intermediary’ and ‘fee-payer’?
The fee-payer is responsible for the tax liability and therefore the risk of an end client’s incorrect determination, and is always the lowest party in the chain. If they’re not the closest one to the contractor in the supply chain, they’re just an intermediary with the responsibility of passing the SDS onto the next party.
Consequences of non-compliance
What are the tax implications for contractors of being found inside or outside IR35?
If determined inside IR35, the fee payer would be required to deduct Income Tax and National Insurance Contributions from a contractor’s payment, as if they were a permanent employee. This would reduce the contractor’s take home pay unless the client is willing to pay more and offset the difference.
Outside IR35, on the other hand, means a contractor’s engagement has been determined as a genuine business-to-business relationship and therefore self-employed for tax purposes.
For those working outside IR35, if HMRC decide to challenge your determinations, there could be an IR35 inquiry. They have the power to open investigations up to four years in the past for no reason at all, six years if careless or negligent behaviour is suspected, and 20 years if they suspect fraud.
After an HMRC inquiry, if a contractor is found to be a disguised employee and they were the one to determine their engagement’s status because their client is a small business, wholly overseas or it’s related to a contract prior to April 2021 in the private sector or 2017 in the public sector, they’ll need to make a deemed payment. This will pay HMRC all the tax and NICs that they would have paid as an employee for tax purposes. There could also be interest on top of this, alongside a potential penalty cost (this could be up to 100% of the taxable amount), leading to a large tax bill.
What are the tax and penalty risks for non-compliant businesses and agencies?
If the assignment continued or started after the 2017 or 2021 reforms, and the end client holds responsibility for a contractor’s engagement’s IR35 status, and they’re the fee-payer, then the liability for unpaid tax and additional financial penalties must be paid by them. But if the fee-payer is an agency, the recruitment agency would pay the resulting tax, interest and penalties.
Guidelines for compliance
How can contractors comply with IR35?
For the contractor, IR35 is now mostly out of their hands if their contract occurred after the changes in legislation, but they should still take steps to ensure compliance with IR35. In particular, they should check whether they’re the one who makes the determination or not. The contractor can ask the client or agency for confirmation on who this responsibility lies with, they’re obligated to state which rules apply.
If a contractor does need to determine their assignment’s status, there unfortunately isn’t much guidance except to take reasonable care when considering it.
Regardless of whether they need to establish employment status for tax purposes or not, we recommend seeking external help to ensure contracts reflect how they work. It’s best practice to do this every time a new contract is received, even if it’s for the same company. Status should be reviewed if there’s a change in working practices, as this may impact whether an assignment is found inside or outside IR35.
How can end clients comply with IR35?
Post-April 2017 and post-April 2021, public sector organisations and private sector businesses must look at an engagement’s status, produce an SDS, and send it to the next party in the chain. This should confirm the status determination and the reasoning for its conclusion.
For businesses to comply with IR35, they need to ensure that they assess their onboarding processes, and that operations are in place for establishing status and issuing SDSs. Contracts with both contractors and intermediaries (like a recruiter) should also be reviewed to avoid IR35 risk.
How can agencies comply with IR35?
A recruiter has no responsibility for assessing IR35 status – both before and after the reforms. They do, however, need to pass on the SDS to the next party if either the April 2017 or April 2021 rules apply. And if they’re the fee-payer, they’ll need to ensure they deduct the correct amount of tax and make payment to HMRC.
Resources to aid compliance
HMRC’s check employment status for tax (CEST) tool can be used by all parties to help determine status. However, it’s been found to have issues because it doesn’t test for a key factor (MOO). In fact, our research revealed that in over 22% of cases, it isn’t able to conclude if an assignment is inside or outside IR35. So, if you use the CEST tool, we recommend using other tools and resources alongside it – like our IR35 Status Tool.
This asks between 29–34 yes/no questions to gain a rounded view on the worker’s contract and actual working practices. It produces a valid determination and comprehensive report. If a case is borderline, it will be passed to our in-house IR35 experts for a manual review.
Ensure compliance with Kingsbridge
If you’re unsure how to navigate IR35, we can help – whether you’re a contractor, a recruiter, or an end client. Our friendly team is happy to provide professional advice so you can comply with IR35. Get in touch today.