IR35: Who is responsible?

IR35 is a tax legislation that seeks to ensure that contractors operating via a Personal Service Company (PSC) who are actually ‘disguised employees’ (i.e. working in the same way as an employee) are correctly taxed. This means that they should pay the relevant Income Tax and employee National Insurance Contributions (NICs). Workers, end clients, and recruitment agencies must understand it because, if they don’t comply with IR35, there can be financial repercussions.

Before the public sector and private reforms of April 2017 and April 2021, it was the contractor’s responsibility to determine if an engagement was ‘inside’ or ‘outside’ IR35. However, these reforms – called the ‘off-payroll working rules’ – brought significant changes. They meant that it was now the end client’s responsibility in the vast majority of cases. Yet there are exceptions to this.

In this blog, we’ll be focusing on the subject of who is responsible for determining the status of an engagement in different situations.

Who determines IR35 status?

The end client or the contractor will be responsible for determining the status of an engagement.

Who is responsible for IR35 status in the public sector?

For engagements crossing into or starting after 6th April 2017 in the public sector, the new off-payroll working rules dictate that it’s always the end client – i.e. the public sector organisation – that is responsible for establishing the IR35 status of each engagement.

Who is responsible for IR35 status in the private sector?

From 6th April 2021, the off-payroll working rules extended to the private sector – although they aren’t entirely the same. The end client is the party responsible for determining IR35 status unless they’re classed as a ‘small business’ as per the Companies Act 2006 or they’re based wholly overseas.

In these cases, the responsibility for determining IR35 status will remain with the contractor, as was the case before the reforms.

What constitutes a ‘small business’?

Section 382 of The Companies Act 2006 defines ‘small businesses’ as those that satisfy at least two of the following criteria:

• Annual turnover is below £10.2 million
• Balance sheet total is below £5.1 million
• Have employed an average of 50 employees or fewer during the relevant tax year

What is the process for status determination?

To assess status, the process will involve checking the engagement against several factors. Amongst other tests, there are what are known as the ‘three key status tests’:

• Personal service (including the right to provide a substitute): The right of substitution is crucial to this and concerns whether the worker can supply a replacement to carry out the service they’re performing.
• Mutuality of obligation (MOO): In its purest form, MOO is the obligation for the client to give the contractor work and for the worker to accept it. Understanding if an engagement is subject to it or not requires significant consideration.
• Control: This is how much autonomy the contractor has over the services they provide to the client.

These aren’t the only aspects. There’s a lot more that goes into an IR35 status determination – such as assessing whether the worker is subject to financial risk or is required to supply their own equipment.

What are the client’s responsibilities?

If the contractor is the one to determine employment status for tax purposes, then the end client doesn’t have any IR35 responsibilities. But if the end client is responsible under the off-payroll working rules, then, amongst other things, they’ll need to follow these key steps:

1. Correctly determine employment status for tax purposes

This will require end clients to take reasonable care and consider the aforementioned factors. It’s recommended that they use an expert tool for this, such as the Kingsbridge Status Tool.

2. Produce a Status Determination Statement (SDS)

To meet requirements, clients will need to put together a Status Determination Statement (SDS). This document explains the status decision as well as its reasoning. It needs to be sent to the contractor and the next party in the supply chain (if there is one).

3. Deduct the relevant taxes (if applicable)

If the engagement is ‘inside’ IR35, the ‘fee payer’ then would need to deduct Income Tax and National Insurance Contributions from the worker’s pay. There may also be other tax deductions, such as the apprenticeship levy, if applicable.

The fee payer is the party who sits directly above the worker’s own intermediary. It’s the client if it’s a direct engagement, or it’s usually a recruitment agency that either sits above and/or below the contractor and the end client.

What are the contractor’s responsibilities?

What a contractor needs to do depends very much on if they’re the party to determine status or not. Either way, they should also follow a few key steps:

1. Stay informed

Even if the end client determines the employment status for tax purposes, contractors should stay informed. They should regularly check with the client or recruitment agency to check which rules apply to the engagement and therefore which party is responsible for determining IR35 status.

2. Determine IR35 status

If the contractor is responsible for determining their engagement’s status, and it’s found to be ‘inside’ IR35, then they would need to pay the relevant taxes.

3. Exercise reasonable care

In the absence of comprehensive HMRC guidance, contractors must exercise ‘reasonable care’ when determining IR35 status.

4. Communicate with clients

Maintaining open communication with clients about IR35 status is essential. Knowledge of an engagement’s IR35 status can influence a contractor’s decision to accept work and set proper work expectations. Historically, there has been a lack of open communication between clients and contractors, especially before the introduction of the off-payroll working rules.

What triggers an investigation?

The simple answer to this question is that no one knows – and for good reason. If people knew, then it would trigger behaviours to avoid an investigation, so that’s why HMRC doesn’t publicise this information.

Random selection, late tax returns, RTI, a change in IR35 status, employer compliance checks… these are just some of the reasons you might be picked for an IR35 enquiry.

How can an investigation be avoided?

As HMRC doesn’t publish the criteria around what triggers an IR35 investigation, these enquiries appear to be very random. They can happen to anyone – no one can avoid being seen by HMRC. Consequently, it’s key that every party complies with the off-payroll working rules. Even though the risk of an IR35 enquiry may be low, it’s best to ensure compliance and have that peace of mind.

What is HMRC’s ‘Connect computer system’?

HMRC has a supercomputer called the ‘Connect computer system’. It designed this to improve its ability to discover who is understating or underpaying taxes. It doesn’t just look at the information that’s inputted into the tax returns of the self-employed – the Connect system accumulates data from government and corporate sources (like banks and peer-to-peer lenders), social media profiles, and more.

If the information doesn’t match up with that of the data in the tax return, this could flag the account in question and trigger an investigation.

The Connect system has access to a wide range of information, including details related to vehicles purchased and Land Registry records. However, it can’t see information like contracts and the terms within them.

Who pays if caught by the off-payroll working rules?

If the off-payroll working rules apply and the end client makes an incorrect IR35 status determination, the fee payer would be liable for the related financial penalties. If the IR35 rules apply and it’s the contractor who assesses employment status for tax purposes, then it would be them who would need to pay.

What insurance is available to help?

There are insurance options for both contractors and clients which protect them if they’re caught by the off-payroll working rules and have to pay the related costs. Off-Payroll Protect covers both the fee payer and end clients who engage with workers – either directly or via an agency. It assures those in the supply chain and helps them to feel prepared if there’s ever an investigation.

This policy insures any ‘outside’ IR35 status determinations and covers the costs of defending an IR35 enquiry.

There’s also IR35 Protect for contractors. This aims to protect workers by covering the costs of an IR35 enquiry and its repercussions. These repercussions could include the costs of defence, taxes, interest, and penalties.

Seek specialist help with IR35 and the off-payroll working rules

As you can see, a lot of effort goes into effectively determining IR35 status and the other responsibilities that come with the legislation and its reforms. But support is available if you need it.

Along with offering insurance products and tools related to IR35, we can give specialist advice. Please get in touch with us if you need any help from our experts. We’ve also provided answers to some frequently asked questions below.

FAQs

Who is liable for IR35 status determinations?

This depends on which IR35 rules apply. It was always the contractor who held responsibility for determining IR35 status until 6th April 2017. From this date, new rules changed this to the end client for all public sector engagements. On 6th April 2021, this extended to the private sector – with some exceptions.

Is the end client liable for IR35 status determinations?

End clients in the public sector are responsible for determining the IR35 status of engagements from April 2017. Private sector end clients also became liable for this from April 2021, unless they’re based wholly overseas or classed as a small business as defined by the Companies Act 2006.

Are contractors liable for IR35 status determinations?

Contractors were responsible for determining IR35 status for public sector engagements before April 2017, and private sector engagements before April 2021. They are no longer responsible unless the Companies Act 2006 would define the private sector end client as a ‘small business’ or they’re based overseas entirely.

How far back can an investigation go?

HMRC can launch an enquiry up to four years in the past. This increases to six years if it believes the party in question didn’t take ‘reasonable care’. If HMRC suspects fraud, then an enquiry can look back at the previous 20 years.

Who decides if a contract is ‘inside’ or ‘outside’ IR35?

For public sector engagements before 6th April 2017, it is the contractor who would determine whether an engagement was ‘inside’ or ‘outside’ IR35. From this date, it changed to the end client.

For private sector contracts before 6th April 2021, it was also the worker who would determine an engagement’s IR35 status. From this date, it also switched to the end client – except in specific circumstances.

What happens if an engagement is ‘inside’ IR35?

When a contract falls ‘inside’ IR35, the worker will be an employee for tax purposes. As a result, they will pay the relevant Income Tax and employee National Insurance Contributions. If the engagement is ‘outside’ IR35, then they would be self-employed for tax purposes and can operate through a Personal Service Company (PSC).

Is it better to be ‘outside’ or ‘inside’ IR35?

‘Outside’ IR35 engagements are more tax-efficient because the worker is genuinely self-employed for tax purposes and has their own limited company. However, a correct determination of employment status for tax purposes is key. Even though ‘inside’ IR35 may be less beneficial financially, it’s better to have an accurate IR35 determination as otherwise there may be an enquiry and significant financial repercussions.