UPDATE: IR35 applies to services provided on/after 6 April 2020 (rather than payments made)
In advance of the results of the Government review and consultation which got underway in January 2020, announced in February 2020 that the proposed extension of the off-payroll working reforms to the private sector (which will make medium and large-sized organisations responsible for making the decision about whether off-payroll workers are employed or self-employed for tax purposes) will now apply only to made for services provided on or after 6 April 2020. Previously, had proposed that the rules would have applied to any payments made on or after 6 April 2020, regardless of when the services were carried out. This is set out in updated guidance in the HMRC’s Employment Status Manual available
IR35 – A brief history
Like most IR35 practitioners, I have fielded many calls and emails from worried clients regarding the IR35 Private Sector Reforms coming into effect on 6 April (IR35+).
With less than 2 months to go, Contractors and End Clients alike are concerned about what IR35+ could mean for them and their business. So let’s explore what all the fuss is about and seek to calm some nerves. I have also included a helpful glossary at the end of this piece including all of the IR35 key terms, in an effort to help you better understand IR35.
First things first…what is IR35?
IR35 is tax legislation introduced in 2000 designed to combat tax avoidance by Contractors supplying their services to end engagers via an intermediary, such as a limited company (AKA Personal Service Company), who would otherwise for all intents and purposes be an Employee if the Intermediary was not used (and therefore paid via PAYE). This is often referred to as ‘disguised employment.
Such arrangements are appealing to Contractors because of the considerable savings in tax, with most employing a tax-efficient combination of salary and dividends. They also appeal to the End Client due to the savings in employer NIC.
Take the example of an Employee and a Contractor both earning £40k a year. The Contractor will take home near £5.5k more than the Employee, representing 81% of their earnings. The End Engager will also save in excess of £4k in employer NIC. Now it becomes clear why such arrangements are both fruitful for those involved and a target for HMRC.
IR35 – A brief history
- April 2000 – IR35 came into force.
- April 2017 – Public Sector Reform came into force.
- October 2018 – Private Sector Reform confirmed.
- July 2019 – Draft legislation for Private Sector Reform published.
- April 2020 – Private Sector Reform comes into effect on 6 April.
Private Sector Reform – The Basics
Currently, Contractors within the private sector are responsible for assessing their IR35 status, not the End Client. With effect from 6 April 2020, this will all change, with End Client, much like public sector organisations after April 2017, required to assess the IR35 status of the Contractors they use and, where appropriate, deduct income tax and NIC at the source. As such, Contractors and End Clients should urgently review their Work Practices to ensure they are on the right side of the law. Employer NIC would appear to be the main driver behind the Government’s pursuit of IR35+, with the Government suggesting there is more than £1 billion at stake in moving contractors onto PAYE.
Clients of mine often get unduly concerned about services they are contracting out, such as office cleaners or alike. Such an arrangement would not engage IR35. You are asking for a service to be provided and you do not care who delivers it. It is important to distinguish between a contracted service and a personal service, the latter of which would potentially engage IR35, such as where you engage an IT consultant to personally work on an IT project. If say, for instance, the cleaning company you contract with uses Contractors to undertake the cleaning, that is their concern, not yours as an End Client.
What factors does HMRC use to decide whether an arrangement is ‘inside’ or ‘outside’ IR35?
In two words…employment status. HMRC apply a number of tests to judge whether a Contractor falls within the clutches of IR35. These can be helpfully split into ‘main factors’ and ‘secondary factors’ referring to their importance in swaying HMRC’s decision one way or another:-
- Personal Service – is the Contractor able to send a Substitute or does he have to do the work himself? Is there a Right of Substitution?
- Control – does the End Client tell the Contractor when to do the work, where to do it, what to do and how?
- Mutuality of Obligation – is the End Client obliged to offer work (and pay the Contractor) and is the Contractor is obliged to take it?
- Equipment – is the Contractor provided with all their equipment by the End Client or do they provide their own?
- Insurance – does the Contractor have business liability and professional indemnity insurance?
- Employment benefits – does the Contractor receive holiday and/or sick pay, or pension contributions?
- Financial risk – does the Contractor take any financial in undertaking the work? Do they risk non-payment or would they have to return and fix any poor work without further payment?
- Opportunity to profit – does the Contractor have the opportunity to profit through sound business management? For instance, margins on materials supplied?
- Basis of payment – is the Contractor paid via PAYE or does he submit an invoice? How regular are his payments?
- Intention of the parties – is there a contract in place which expressly sets out the relationship between the parties as one of self-employment?
- Part & Parcel of organisation – does the Contractor attend staff meetings, have End Client email footers on their emails or receive Employee benefits?
- In business on own account – does the Contractor have multiple clients? Are they VAT registered? Does they employ anyone else or use sub-contractors?
IR35 Solicitors in Colchester, Ipswich & North London
I am a private sector End Client who engages Contractors, should I be worried about IR35+?
If you are a small business no. if you are a ‘medium – large’ business then yes. Unlike the Public Sector Reforms introduced in April 2017, IR35+ will operate a small company exemption. Therefore, only medium and large businesses in the private sector who are the End Client will be affected. The Government has indicated they will use the criteria already found in the Companies Act 2006 when determining what is a ‘medium-large’ business. This means that under IR35+ a business will be considered ‘medium-large’ if it has two or more of the following:-
- Turnover of more than £10.2m
- The balance sheet of more than £5.1m
- 50 or more employees
These financial measurements have to take place every tax year looking back to the previous 2 years. If the End Client exceeds 2 of the 3 measurements for 2 years in a row then at the beginning of the next tax year, they are deemed a medium-large business and therefore IR35+ will apply. The only way to stay outside of the reforms is to stay small; where the End-Client does not meet two or more of the above financial measurements, responsibility for determining the IR35 status of a contract remains with the Contractor (or Personal Service Company to be exact) and IR35+ does not apply.
The main reason why medium-large employers should be concerned about IR35 is the new ‘Transfer of Liabilities’ provisions being introduced. Instead of the current penalty regime, if the End Client does not follow every step of the reforms and engage with them properly, the End Client can be on the hook for not only the employer NIC but also the Contractor’s own income tax and NIC. As you can imagine, for End Clients who currently use 100’s if not 1000’s of Contractors (as some private sector organisations do), the fines could run into several hundred thousand pounds, if not more.
What about Group Companies?
A common misunderstanding amongst medium-large End Clients is that they can avoid IR35+ by setting up or using a smaller subsidiary for engaging with their Contractors. They are wrong. HMRC soon cottoned onto such anti-avoidance measures when they were consulting on IR35+. Therefore, all medium-large End Clients should be aware that the above financial measurements apply to group companies too. Therefore, if the group company meets 2 of the 3 measurements, then all the companies in that group, no matter how small, will still be caught by IR35+. They also apply if the group’s HQ is overseas and to joint ventures.
I am a ‘medium-large’ End Client…what should I do?
If your business meets 2 or more of the above, the first thing you need to do is assess every contractor’s IR35 status to determine whether they fall Inside or Outside IR35. Expert advice is key. You will then need to issue Status Determination Statements (SDS) to all contractors. Currently, there is only informal notification to Contractors that they are inside IR35. From 6 April, a formal process must be followed where medium-large End Clients will have to formally tell a contractor (and any Agency, where involved) their decision on IR35 status before they can start withholding income tax and NIC. The End Client must provide an opportunity to appeal their decision and have a dispute resolution process in place. Any contracts that flow over from March to April 2020 will have to issue SDS’ to continue deducting income tax and NIC. SDS’ does not just apply to new contracts but any continuing into April 2020 and beyond.
One hopes that the private sector does not follow the lead of large swathes of the public sector in lazily issuing Blanket Decisions to Contractors that they were Inside IR35
Conversely, IR35+ could prove hugely beneficial to small businesses, the main reason being that overnight they will become much more attractive to contractors due to the fact that as a result of the Small End Client’s falling outside of IR35+, they are still able to pay their Contractors gross, meaning more money in the contractors back pocket in most cases (and saving in employer NIC for the small End Client too).
What about if I use an Agency? Is this a way around IR35+?
In a nutshell, no. Where the End Client is medium-large, they still remain liable. This is on the basis that they know the terms and conditions on which they engage with their Contractors better than anyone. As such, the End Client will have to inform both the Contractor and the Agency (sometimes referred to as the ‘Fee-Payer’) about the decision they have come to. It is then for the Agency to do the heavy lifting in terms of deducting income tax and NIC from the Consultant’s pay packet. In practice, this is likely to result in the Agency charging this burden back to the End Client, not least due to the employer NIC and the administrative costs in paying their Contractors via PAYE.
How can you help?
HMRC has, perhaps optimistically in view, estimated that 95% of all End Clients will not be subject to Ir35+because of the Small Company Exemption. However, the IR35+ brings in a new dawn of IR35, and End Clients must take steps now to ensure that they have the right advice and adequate procedures in place to deal with the additional requirements, or face significant fines from HMRC.
IR35 is a very complex area of law and therefore it is important that you get expert advice.
Lloyd Clarke is an IR35 specialist, having advised many Contractors and End Clients over the years on their IR35 status, including national TV presenters. Lloyd offers value for money fixed fees for reviewing your working arrangements and contractual documentation, advising you on the changes which need to be made to ensure HMRC don’t come knocking on your door with a large fine. If you are a Contractor or End Client in need of advice or support around IR35 please contact Lloyd Clarke today on 01206 239761 for a free initial consultation.
Agency: Recruitment Agency through which a Personal Services Company is engaged through to work for the End Client. Can be seen by IR35 as the Fee Payer.
Blanket Decision: The approach by an End Client to determine its Contractors and assignments collectively instead of making individual decisions.
Contractor: A person providing a service to a specific client (for the purposes of this article) via a limited company of their own, who is usually a director.
Deemed Employment: When IR35 applies, i.e. the contractor is Inside IR35, the earnings for the engagement of the intermediary will be in the form of deemed payment, also called the deemed employment payment – as they are deemed to be the income of the contractor.
Employee: An employee is an individual who is employed under an employment contract who is expected to work regular hours, expects payment & benefits, and has tax and NIC deducted from their salary. The employee is subject to supervision, direction, and control.
End Client: The End Client is the party the contractor is engaged to deliver a service to. For the Public Sector HMRC gave a defined list for the End Client, for the Private Sector the definition of the End Client is still under consultation with further clarification expected in due course.
Equipment: Including heavy machinery, industrial vehicles, or high-cost specialist equipment – but not including phones, tablets, or laptops; vehicles – including purchase, fuel, and all running costs (used for work tasks, not commuting. This also includes other expenses – including significant travel or accommodation costs (for work, not commuting) or paying for business premises outside of the contractor’s home.
Fee Payer: The Fee Payer is defined as the business, agency or third party that pays the Personal Services Company (PSC), often referred to as a Limited Company.
Inside IR35: Inside IR35 means that HMRC deems a contractor as an employee and is therefore liable for income tax and National Insurance deductions at source. This is also referred to as In Scope.
HMRC: Her Majesty’s Revenue & Customs, the UK tax service.
IR35: The name given to the HMRC legislation that seeks to identify Disguised Employment.
Intermediary: An intermediary will usually be the contractor’s own Personal Service Company. They could also be a partnership, a Managed Service Company, or an individual.
NIC: National Insurance Contributions.
Outside IR35: Outside IR35 means that a contractor is not classed as an employee and does not have the burden of income tax and National Insurance deductions. This is also referred to as Out of Scope.
Part and Parcel: Being Part and Parcel is the level at which the contractor is integrated and embedded within the organisation.
Personal Service: Personal Service is what differentiates a contractor from an employee. An employee is employed for them specifically, whereas a contractor is engaged for their unique expertise, which can be replaced and should be devoid of ‘personal’.
Personal Services Company (PSC): A Personal Services Company is defined as a Limited Company with one director who is the contractor.
Right of Substitution: Right of Substitution allows the PSC to send a replacement who meets the required criteria.
SDS: Status Determination Statement – An assessment provided by the End Client which declares the employment status of an assignment with the justification for reaching the deemed status determination.
Small Company Exemption: An exemption for End-Clients who are small businesses as defined by the Companies Act 2006 which means meeting two or more of the following criteria:
- Annual turnover is no more than £10.2 million
- The balance sheet total is no more than £5.1 million
- No more than 50 employees.
Where the End-Client meets two or more of these criteria, responsibility for determining the IR35 status of a contract remains with the Personal Service Company and IR35+ does not apply.
Substitute: An alternative worker who undertakes work in place of the principal contractor, but is paid by the principal contractor.
Working Practices: The understood and inferred behaviours and engagement the organisation has with its contractors.