What is IR35?
What is IR35? In simple terms, it’s a tax legislation that aims to prevent ‘disguised employees’, i.e. those who are self-employed and receive the related tax advantages, whilst working in a similar manner to those who are employed.
IR35 impacts everyone in the supply chain, including contractors, the end client, and recruitment agencies. Without sufficient knowledge on the matter, they won’t know if a worker is ‘outside’ or ‘inside’ IR35. By being determined ‘inside’, they’ll be classed as an employee for tax purposes and have to pay the related tax obligations. ‘Outside IR35’, however, will reduce their tax burden. But, if they’re wrongly labelled as such, they’ll pay the incorrect levels of Income Tax and National Insurance Contributions (NICs), which could lead to significant penalties.
In this blog, we’ll answer ‘what is IR35?’ and other key questions, including how it’s evolved, when the rules apply, and who it impacts.
What’s the purpose of IR35?
IR35, commonly referred to as the ‘intermediaries legislation’ or ‘off-payroll working rules’, aims to ensure there’s no ‘disguised employment’. It’s key to determine their ‘IR35 status’ or ’employment status’ for tax purposes, as this will affect the taxes that the worker and other parties in the supply chain need to pay.
What does ‘disguised employment’ mean?
It’s helpful to define what ‘disguised employment’ is. These are those who receive payments from a client through their own intermediary (such as a limited company), but their relationship with the end client is the same as if they were a permanent employee.
What’s the history and evolution of IR35?
IR35 became a legislation in 2000 via the Finance Act. It was specifically introduced to eradicate the loophole in the tax system and combat tax avoidance. Though it’s had a controversial history ever since.
For a long time, the tax legislation remained the same with the worker holding responsibility for determining their IR35 status. Then in the 2016 Budget, the government announced reforms that would place this responsibility with the end client instead. The fee-payer party would also be responsible for deducting Income Tax (PAYE) and employee National Insurance Contributions (NICs), and paying these to HMRC.
These changes would be implemented first in the public sector in 2017, then the private sector in 2020 (though this was later delayed by a year due to the pandemic). We talk more about when the reforms happened, and their impact on the private and public sector, later in this blog.
How did the term ‘IR35’ originate?
It was named as such because it was announced in the 35th Inland Revenue press release related to the 1999 Budget which it was revealed in.
Who’s affected by IR35
What types of workers and businesses are impacted?
The off-payroll working rules impact various workers and businesses:
- Those who deliver their services via their own intermediary to a client (a ‘client’ can also be called an ‘end client’, ‘engager’, or ‘hirer’)
- End clients who receive services from a worker through this intermediary
- Agencies or other suppliers providing workers’ services via this intermediary
Generally, this intermediary will be a limited company, also known as a ‘PSC’ (personal service company). The contractor will be both a director of this company, and a fee-earner. Though, the intermediary could alternatively be a partnership, or the worker could provide their services through another individual.
The IR35 reforms introduced different rules for mid- and large-sized private companies and public sector bodies. Only these have the responsibility of defining employment status; if the client is a small business, the responsibility of determining status and tax liability still rests with the contractor.
The legislation doesn’t apply if a worker is employed by an umbrella company or works as a sole trader.
All-sized agencies have some liability for IR35, especially if they’re the ‘deemed employer’. They’ll have responsibilities, such as passing down the Status Determination Statement (SDS) to the next party in the chain. Plus, if they’re the ‘first’ agency in the supply chain – the person or organisation the worker contracts with – they’ll need to be aware that if HMRC can’t access outstanding Income Tax or NICs from parties below them in the chain, the liability may be transferred back to them.
What are Personal Service Companies?
Personal Service Companies (PSCs) don’t have a legal definition. Usually they’re in the form of a contractor’s limited company that they control and have some interest in. It’s the organisational structure in which they provide their services to the client.
Determining employment status
What factors are considered?
To understand if a contractor works inside or outside IR35 or not, you first need to assess their written contract terms and actual working practices, i.e. how their work is conducted between themself and the client. You should consider three main factors: personal service including the right of substitution, mutuality of obligation (MOO), and control.
Though, you should also be aware of other factors:
- Whether a financial risk is being taken
- If the employee is ‘part and parcel’ in the client’s organisation
- Whether they’re in business of their own accord
- Provision of equipment
What’s the role of control, substitution, and mutuality of obligation?
These work as follows:
- Personal service including the right of substitution: This is the worker’s capability to supply a replacement contractor to perform the service which is being contracted. If the right of substitution exists, they won’t be caught by this aspect of IR35 and it will prove to be impactful on the status of the engagement.
- Mutuality of Obligation (MOO): In its purest form, this is an obligation for the client to provide work, and the worker to perform it. However, this aspect must be explored in more detail to determine whether it exists.
- Control: If there are aspects that indicate autonomy over the services, specifically in relation to how and when the contractor provides their services, this suggests the assignment isn’t caught by IR35.
Inside and outside IR35
What does it mean to be ‘outside’ or ‘inside’ IR35?
‘Inside IR35’ is where the worker’s engagement is determined as being one of employment for tax purposes.
To be ‘outside’ means the worker’s engagement would be considered self-employed for tax purposes. Their engagement is seen as a genuine business-to-business relationship.
It’s always been the case that it’s the engagement, or contract or assignment, that is ‘inside’ or ‘outside’ IR35.
What are the tax implications?
In tax terms, a contractor who is inside IR35 needs to pay broadly the same tax as if they were a permanent employee. But if they’re outside, they’ll be considered genuinely self-employed and have a reduced tax burden as a result.
Intermediaries legislation reforms and changes
Who has the responsibility for determining IR35 status now?
The reforms to the off-payroll rules transferred the liability for determining employment status from the worker, to the end client. These reforms were first introduced in the public sector from 6th April 2017. They were later extended to the private sector from 6th April 2021.
The changes also introduced the phrase ‘fee-payer’, which is the party that’s closest to – and has the responsibility of paying – the worker. For direct engagements, this is the client. However, in longer supply chains with agencies, it would be the agency closest to the worker’s intermediary who has the fee-payer accountability. They’re then obliged to deduct PAYE, NICs, and the Apprenticeship Levy (if applicable) from the worker’s pay if the worker is determined inside IR35.
There are exceptions to the reforms. The new IR35 rules don’t apply to small businesses. In addition, engagers who are situated wholly overseas also don’t have to abide by it. This means the off-payroll rules reform only affects those private sector businesses classed as medium and large, in accordance with the Companies Act 2006.
How have the public and private sectors been impacted?
Due to the changes, many independent professionals were unfairly forced to close their limited companies and become employed, either for an employer or through an umbrella company. This resulted in some private and public sector clients losing out on skilled contractors. Other clients have had to pay the cost to retain it, increasing their self-employed workers’ day rates to make up for the additional tax they have to pay.
Were the off-payroll rules reforms repealed?
Briefly, the UK government opted to repeal the legislation. This was announced by the then-Chancellor, Kwasi Kwarteng, on 23rd September 2022. However, on 17th October 2022 the new Chancellor, Jeremy Hunt, revealed this repeal to the off-payroll rules had been reversed instead. At the time of writing, there have been no more U-turns and the 2017 and 2021 IR35 reforms remain in place.
Compliance with IR35
What’s the role of HMRC in enforcing IR35?
HMRC has to undertake various activities to enforce the off-payroll rules. This includes carrying out detailed – and costly – enquiries into the individual worker’s status.
In most cases, with expert support, HMRC enquiries can be closed down very quickly. Sometimes their investigations could lead to a First-tier Tax Tribunal, though HMRC have suffered many defeats in the courts.
What are the consequences of being found a ‘disguised employee’?
If a worker is found to be a ‘disguised employee’, depending on the rules operative, the contractor or the fee-payer may have a tax liability bill. On top of this, they might have to pay interest and even a potential penalty cost.
What are the requirement for companies to take ‘reasonable care’ ?
It’s key to note that a ‘blanket approach’ to assess all roles doesn’t count as ‘reasonable care’, and reasonable care is important for whoever is assessing. Many choose to seek out specialist advice so they can be certain, and avoid a HMRC penalty.
Tools and resources for navigating IR35
What is HMRC’s online employment status tool (CEST)?
To help those needing to define a contractor’s employment status, HMRC brought out a specific tool in 2017: Check Employment Status Tool (CEST). Though, this has been highly criticised. It’s resulted in numerous incorrect status findings, including by many government departments. A big issue is that it doesn’t test for MOO. In addition, it fails to come to a conclusion around whether the off-payroll rules apply for about 22% of occurrences as Kingsbridge’s most recent data reveals.
Are there any other resources and tools for determining IR35 status?
There are alternate tools and resources to help you assess employment status, which includes our own IR35 Status Tool. It asks between 29 and 34 yes/no questions to establish a rounded view on the contractor’s contract and working practices. These questions have been carefully selected, so you can receive a valid determination alongside a comprehensive report. Any borderline cases are passed to our in-house IR35 experts for a manual review, providing further assurance.
Mitigating IR35 Risk
How can you avoid falling foul of the off payroll rules?
To avoid the risk of IR35, you should know a worker’s accurate IR35 status, even if this turns out to be ‘inside’. Although this won’t lead to the benefit of paying less tax, it’s better than risking the percussions of IR35 and being seen to commit tax avoidance. Not only can the penalties come to a significant amount, there’s cost involved in a HMRC battle.
Insurance is always a good idea, as it helps towards the costs of defending against a HMRC enquiry, and pays for any costs should it be found that an engagement was inside IR35.
Follow the off-payroll rules with Kingsbridge
The importance of understanding and complying with IR35
Everyone in the chain should understand how IR35 and the reforms affects them, then they can take the relevant actions to protect themselves against the related risk, like financial repercussions. In addition, businesses and recruitment agencies can figure out how to hold onto contractors who can deliver the needed expertise and experience that employees cannot.
Stay updated on the IR35 changes
As you’ll have realised from this article, IR35 is continuously changing, and you need to be aware of these changes to avoid any consequences. Here at Kingsbridge, we’re IR35 experts, and you can turn to us for specialist advice. Our blog is regularly updated with insights and new legislation changes.
If you require any guidance, don’t hesitate to get in touch with our friendly team.