A Complete Guide to Off-Payroll Working for Private Sector Clients: What’s IR35, what’s changing, and how you can prepare
What is IR35?
Introduced in April 2000, the Intermediaries’ Legislation, or IR35, is a tax law that targets ‘disguised employment’. It concerns freelancers and contractors who provide their services via a Personal Service Company (PSC), to ensure that the correct amount of Income Tax and National Insurance Contributions (NICs) is paid.
If certain conditions are met, then under IR35, the earnings of the company are considered to be a ‘salary’ on which Income Tax and NICs are payable - referred to as ‘inside’ or ‘within’ IR35.
IR35 applies when these three conditions are met:
When does IR35 apply?
An individual performs services for another (the client)
These services are provided under a contract that involves an intermediary (a Personal Service Company)
If the services are provided under a contract directly between the individual and the client, the individual would be regarded as an employee of the client
Testing for employment status
Understanding whether or not the third criteria above is met is what makes IR35 a complex issue and creates uncertainty. The basis for this is that there isn’t a distinction between employment and self-employment in statute. So, it’s quite easy for two experts to reach a different opinion; after interpreting a number of factors and relying on past judgements in case law.
Whilst over 50 years old, the Ready Mixed Concrete (1968) case is still the most relied upon case law used to defend employment status and IR35 cases to this day.
Its importance is based upon the specific criteria it stated, that must exist for a contract to be one of employment. These three tests are Right of Substitution, Control, and Mutuality of Obligations.
In relation to IR35, the ‘right to substitute’ is the right that a limited company contractor has to send a replacement to perform a contracted service. If a worker is contractually obligated to personally perform services for a client, it indicates that the contract may be one of employment and is therefore inside IR35.
Control is one of the main factors when assessing employment status and is a fundamental test for IR35. IR35 status depends on how much control the contractor has over the work they do for their client.
If the client dictates where the contractor works, when they work and how they work, this indicates that they are controlled as an employee and again, indicates that their contract is within IR35.
It is worth noting that even if the right of control is not exercised but nevertheless exists, it is enough to satisfy this indicator.
For an employment relationship to function, there has to be a contract of employment. In short, there’s an obligation on a ‘work-provider’ to provide work and an obligation on the individual to perform that work. This is known as a mutuality of obligation, or M.O.O.
If the contractor expects their client to give them work, and the client expects the contractor to complete it, the contract is likely to be inside IR35. And, so we’re clear, an obligation is a person’s legal requirement to do something particular in the future.
Furthermore, if the contract states that they can’t take on another client while working for their current client, it also indicates that they are working inside IR35.
What does ‘right of substitution’ mean?
What does ‘control’ mean in relation to IR35?
What is ‘mutuality of
What's changing and why?
In April 2017 amendments to IR35 were introduced for individuals who worked for clients within the Public Sector. This change in the legislation was called ‘Off-Payroll’ working, as it applied to those working within the Public Sector, who were not directly employed or on the payroll - so contractors, freelances and business owners.
The new rules transferred the responsibility for assessing the IR35 status of a contract from the individual performing the work through their PSC, to the engager (client).
Where the contract is deemed to be within IR35, the responsibility for the reporting and paying of the appropriate Income Tax and NICs also moved to the client (or the ‘fee payer’ if some other party within the supply chain pays the individual’s PSC).
In April 2020, the Public Sector amendments will be extended to include all medium and large Private Sector businesses. Where an individual is engaged via a PSC, by a small business, the original IR35 rules will still apply, meaning the individual will assess their own IR35 status and is responsible for paying the correct amount of Income Tax and NICs.
1. Number of Employees No more than 50
2. Annual Turnover No more than £10.2 million
3. Balance Sheet Total No more than £5.1 million
The definition of a small business, as laid down by the Companies Act, is when a business satisfies two or more of the three qualifying conditions within a year.
Defining a small business
Note: Conditions 1 and 2 are also expected to be used to determine the size of non-incorporated businesses which are not covered by the Companies Act legislation.
There are anti-avoidance provisions to ensure that a company cannot qualify as a 'small business' if they are part of a group.
Responsibility for assessing IR35 at a glance...
HMRC has stated that there is evidence to suggest the current rules are not working effectively, as only 10% of PSCs that should be assessing their contracts as inside IR35 are, in fact, doing so.
The cost of this non-compliance in the Private Sector was estimated to be £700m for 2017/18 and HMRC are projecting this figure to reach £1.3bn in 2023-24. This increase is estimated on the basis that the number of individuals working via a PSC is continuing to grow.
HMRC have found it very difficult to investigate individual PSCs due to the amount of resource required to do so effectively.
Why the changes?
How you can prepare
To prepare for April 2020, a medium or large business will need to understand the choice available, based upon the options created by assessing a contract as inside or outside IR35.
Understanding your options
Where it can be demonstrated that a contractor is outside IR35, it is satisfactory to continue to pay the contractor’s PSC the gross contracted rate. There is no need to make any deductions for Tax & NICs nor is there any requirement to record this via the company payroll.
Note: It may be necessary to amend the current contractor working practices to place the assignment outside IR35.
Simply bearing the additional cost of the Employer’s NICs applied to the contracted rate
Incorporating Employer’s NICs into the contractual rate so it’s borne by the contractor
Engaging the contractor as a temporary employee. However, this subsequently means an increased cost of Employer’s National Insurance plus the cost of benefits associated with being an employee
In cases where the contract status is within IR35, the client is liable for Employer’s National Insurance on the contracted rate. The contractor will no longer receive gross payments, rather a ‘net salary’ after Income Tax and Employees NICs are deducted.
The options for the client are:
Increasing the contract rate to keep the contractor on a similar ‘net take home’ as if assessed as outside IR35.
This also means a significant cost increase as additional Employer’s National Insurance would be liable on the increased contract rate
Moving the responsibility for assessing a contract for IR35, from the contractor to the client, may seem like a subtle change. However, the key test to determine IR35 status (employment status test), is both complicated and uncertain.
The test is not a simple tick box exercise; each contract must be viewed against different factors contained within both the contractual and ‘day to day’ arrangements of the engagement. For this reason two employment status experts could review the same arrangement and come to different conclusions.
In an effort to help clients test and determine the IR35 status of a contract, HMRC developed the online tool, Check Employment Status for Tax (CEST).
Unfortunately the CEST tool has been heavily criticised by experts due to the following:
- It ignores a fundamental test of employment; Mutuality of Obligations
- It only gives a clear answer in 85% of cases
- The questions and answers expect a reasonable knowledge of IR35
- Whilst HMRC states that the result of this test can be relied upon if challenged, it comes with a big caveat in that if HMRC believe the correct answers have not been input they will override the tool result
Note: Use of the ‘CEST’ tool is not mandatory. A client may use alternative tools available, outsource the testing to external professionals or simply devise their own process.
Where a client determines that IR35 does not apply to a contract, they inherit a tax risk if HMRC choose to investigate, and disagree with the decision.
Even a determination that IR35 applies can carry a risk if the amount of Tax and NICs due is calculated and paid incorrectly.
Where there are several parties within the supply chain, the liability will rest with the party that fails to meet its obligations. Should the supply chain involve any offshore elements, liability will rest with the last UK entity.
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Employer’s NICs in addition to the contacted rate, as previously mentioned. The Apprenticeship Levy may also need to be considered.
Contractors may seek an increase in rates to make up for the additional tax liability they will suffer.
The reaction to the amendment, which has already taken place in the Public Sector, saw examples of contractors terminating their contract and subsequently leaving a project
Loss of key individuals
An inside IR35 determination deems the contractor employed for tax purposes but not for employment rights.
There is a risk that the contractor may bring a claim for employee rights and benefits, such as holiday pay.
Blanket determination of ‘inside IR35’
Given the complexity of IR35 assessments, the issues with ‘CEST’ and the financial risk for clients, one option to avoid these concerns would be to simply declare all off-payroll contracts inside IR35.
Whilst there were examples of some Public Sector bodies relying on this, the legislation does deter against it with the inclusion of a ‘reasonable care’ clause.
“HMRC is clear that it is not right to rule all engagements to be within or outside of the rules irrespective of the contractual terms and actual working arrangements.”
Declaring all off-payroll contracts as inside IR35 also brings its own consequences and potential risks such as:
Practical concerns of an ‘inside IR35’ determination
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The contractor’s PSC would still issue an invoice with the full amount of VAT payable via the client’s accounts payable system.
However, the net invoice amount is now payable via the payroll. To facilitate this, new process and systems development may be required
The new reforms will apply to all payments from 6th April 2020. This means any work completed in March 2020 but invoiced and processed after 6th April, would fall into scope. Considerations must therefore be made when implementing timescales.
Given the consequences noted about an inside IR35 determination, careful thought should be given to the timing of any communications to the contractor base
Some contracts may already be in place that will span the April 2020 deadline.
In most cases the contractor will have determined the contract outside IR35, so this could lead to a difficult conversation, as contractors may be fearful of a retrospective investigation by HMRC
And assess whether external resource or partners are required
Resource the project
Preparation - what you can do now
Assess your workforce
Can you distinguish the contractors and the suppliers? How many contracts will terminate before April 2020? How many will you renew?
Segment your contractor population
Which contracts are clearly inside IR35? Which are clearly outside IR35? Who may leave and what action should you take?
Consider your IR35 assessment process
How will you assess contract status e.g. CEST? Who will perform the assessment? Do you need to work with an external professional? What internal resources may you need?
Identify stakeholder concerns
What issues may your internal management teams and third parties within the supply chain have?
Review systems & processes
What challenges will the reforms bring to your current processes and systems for handling off-payroll contractors? Are you equipped to calculate, deduct and report on the necessary deductions for contracts within IR35?
Consider impact of costs
As mentioned previously there are a number of options for retained contractors determined inside IR35
Set key dates
What do you need to deliver and by when? Who do you need to communicate with and when?
Review budgets and resourcing levels
How will you deal with new contracts post April 2020? How do you secure your supply chain?
As well as helping assess IR35 status, our team of qualified accountants and tax advisors provide a full range of compliant accounting services.
With 20 years’ experience working with businesses and the self-employed, we know our stuff.
With our risk free Employment Umbrella Solution, your clients will be employed by us directly.
We’ll make sure payments are fully compliant, whilst also taking care of any statutory obligations.
Our low cost, efficient solution offers a simple alternative to running your own in-house payroll.
With our support you can reduce your internal costs and spend more time on your business.
How Danbro can help you
Unsure how to assess your contracts and working practices for IR35?
We know IR35 inside out, and have the accreditations to prove it, so we can carry out IR35 reviews for you.
Simply get in touch using the contact form and our experts will be in touch.
Working with us means you’ll have access to great people who make life easy for you and your contractors by giving trusted advice and digital support.
A dedicated point of contact will work with you to support you through these changes.
Ensure they have an authorised business to business contract which is up to date and covers their current circumstances.
Within their contract it would be to their advantage to ensure they are not individually named and that the project they are undertaking is clearly defined with very clear deliverables.
How contractors can prepare
More importantly than the contract is the actual working relationship with the client, and in particular, the contractor’s working practices. It is advisable that a Confirmation of Arrangements document, signed by the client, is obtained which confirms the client’s understanding of the arrangements.
The statement would need to include facts that indicate self-employment, such as a lack of requirement for personal service and control over the provision of the services.
Confirmation of Arrangements
Keep records of particular events which demonstrate acting differently from client employees. E.g. during an IT failure they went home and received no pay, when all employees remained.
They need to differentiate themselves from the actual employees of the client, beginning with the contract they sign and how they act on a day to day basis.
Market their business; choose a business name - not utilising their own, create a logo and business stationery, and sell their services via a company website.
Behave like a business
How Danbro can help contractors
As we provide both accountancy and employment umbrella solutions, we can advise and support on the best way of working, whether inside or outside IR35.
Our clients can transfer seamlessly from working via their PSC to our Employment Umbrella solution and back again, to meet the needs of each assignment and its working practices. What’s more, if they want to keep their Limited company active with us, they can work through our Employment Umbrella for free*.
We also provide free IR35 assessments for existing Limited Company clients and, at an additional cost, can provide an independent working practices review to support a decision on IR35 status.
*Terms & Conditions apply
If you're a contractor looking for more information on IR35 and your working options, speak to one of our team today on 01253 600140, or email@example.com
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