A guide to IR35
What is IR35?
In broad terms IR35 applies where an individual personally provides their labour to a client via their own personal service company or partnership (“Intermediary”) and ignoring the existence of the Intermediary, the individual would be an employee of the end user client.
What are the changes?
With effect from 6 April 2021, the client - rather than the Intermediary - will be responsible for determining whether the IR35 rules apply. If the client decides that IR35 applies, generally the person paying the Intermediary (the “Fee Payer”) will be responsible for deducting income tax and employee NICs and accounting for employer NICs and if applicable the apprenticeship levy. If the client decides that IR35 does not apply, the Fee Payer will, as currently, continue to pay the Intermediary gross. HMRC’s view is that the changes will stamp out what it regards as abuse by contractors who have ignored IR35 and paid themselves by way of dividend rather than PAYE for too long.
Under draft legislation published on 11 July, the client is obliged to inform the entity with which it contracts and also the individual who will doing the work of its IR35 status determination, and the reasons for the determination.
If the Fee Payer fails to apply PAYE, the draft legislation provides for the liability to pass back up the chain to, ultimately, the client. The draft legislation also includes wording that PAYE regulations can be passed which could enable recovery of unpaid PAYE from any person who was a party to the arrangements. It seems that might mean that the individual worker could be targeted by HMRC if the tax remains unpaid.
Making the IR35 determination
In working out whether the contractor would be an employee of the client, clients need to apply the normal employment status tests. These look at various factors, such as: whether the contractor is subject to control; has a right of substitution; is integrated into the client’s business or carrying on business on their own account; and whether there is mutuality of obligation between the parties. These tests are case-law based and are notoriously difficult to apply in different factual situations. HMRC has its own tool, the Check Employment Status Tool (“CEST”). While clients are not obliged to use CEST, it has the advantage that the CEST result is binding on HMRC provided that the relevant information has been correctly inputted into CEST.
However, CEST has been criticised as being biased towards a finding that IR35 applies. While CEST asks a number of questions (for example, about the nature of the relationship between the contractor, the Intermediary and the client, the method of remuneration, who decides on the work schedule and the place and manner in which work is performed, financial risk, any reporting or line management duties and any benefits received by the individual) there is a heavy focus on the right of substitution and no account is taken of the lack of mutual obligations.
The Government has reiterated its commitment to improving CEST and also putting in place an education and support package for businesses. However, clients will still need to ensure that they have a robust system in place for assessing employment status.
Where a contractor disagrees with a client’s determination that IR35 applies, it can challenge the client under what the draft legislation calls a client led status disagreement process. However, all that requires the client to do is consider the challenge, and if it does not agree with the challenge, to advise the contractor of its reasons within 45 days of being challenged.
Are there any exemptions?
“Small” private sector clients will be exempt from the new rules and, subject to anti-avoidance provisions, will not be required to determine whether IR35 applies.
A corporate client will be treated as “small” for a tax year if it satisfies at least two of the following conditions:
- annual turnover is not more than £10.2 million
- its balance sheet total is not more than £5.1 million
- its number of employees is not more than 50
A non-corporate client will be obliged to apply the new rules if either:
- it has both 50 or more employees and turnover exceeding £10.2 million; or
- it satisfies either one of those tests.
Where the client qualifies as a “small”, the Intermediary (rather than the client) will be required to determine whether IR35 applies.
Are we any closer to aligning the employment and tax rules on status?
The IR35 rules only apply for tax and NICs purposes. The new rules do not affect the contractor’s status for employment law purposes or the contractor’s eligibility for statutory payments.
Prepare for the new rules by:
- Training your people on the new rules
- Engage with any agencies used to supply labour
- Identifying contractors supplying their labour through an Intermediary
- Consider the existing contractor population and known pipeline, and undertake status determinations now
- Update your contractors on the changes
- Encouraging your contractors to seek professional advice on the changes and how it may impact on their business models
- Share “dry run” status determinations with agencies/contractors and seek their input into the same to ensure an agreed position wherever possible
- Review terms and conditions to ensure they are fit for purpose
- Review back office systems to ensure they are fit for purpose for the new legislation
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