What is IR35 & why it matters to contractors?
The latest regulation change in IR35 reform aims to recoup millions of pounds by bringing many contractors in line. How does it matter to contractors? Let us find out.
HMRC and the off-payroll working rules
His Majesty's Revenue and Customs, also known as HMRC or HM Revenue and Customs, is an authority responsible for collecting taxes in the UK. In the UK, a worker, also known as a contractor, can provide their services through a limited company, i.e a 'personal service company or 'PSC'. The contractor can also provide their services to another type of intermediary to the client, which can be a partnership or a personal service Company or an individual. The client, in general, is the organisation that receives the contractor's services and can also be referred to as the engager, hirer or end client. The off-payroll working rules can apply when an individual provides services to the above-mentioned categories.
What is IR35?
There were many cases in the past such that workers owning their limited companies would receive payments directly from clients to the company and exploit the revenue. Such workers are called 'disguised' employees. They would distribute company profits to themselves as dividends which are not subject to National Insurance payments. They also exploit the tax system by splitting the company's ownership and saving taxes. To prevent significant losses to the treasury and uncover 'disguised' employees, HMRC's off-payroll working rules called 'intermediaries legislation' nicknamed IR35 was introduced. These intermediaries could be a PSC, the worker's agency, a partnership or an individual. Therefore, IR35 rules are a set of tax laws designed to tax 'disguised' employees and applicable to workers who work for clients through an intermediary. IR35, a tax reform originally introduced in 1999, has come with its latest regulation change effective from April 2021. The IR35 tax reform has been in operation in the public sector since April 2017. After the new regulation change, from 6 April 2021, these tax laws will apply to large and medium-sized private sector companies.
When are IR35 rules applicable?
The IR35 rules can affect companies dealing with workers (contractors) and the workers. These rules are applicable for:
Any worker who's providing their services through an intermediary
A client who gets services from a worker (contractor) through the intermediary
An agency that provides services to workers (contractors) through an intermediary
Although the new rules have become applicable to all sized businesses in the public sector and large & medium-sized businesses in the private sector, some small-sized companies can be excepted from the new rules. To qualify for the tax exemption, the business of such companies must fall under any of the following categories:
Generating an annual turnover of less than £10.1 million
Having gross assets of less than £5.1 million
Consisting of fewer than 50 employees
In these cases, small companies are released from IR35 rules because of their circumscribed budget. However, all the businesses that do not meet this criterion must abide by the IR35 rules and pay their taxes accordingly.
Self Employed IR35 rules and classification
CEST: The Check Employment Status for Tax is a tool that can be used to determine if any worker on a specific engagement needs to be classed as employed or self-employed for tax purposes. Contract Details, Responsibilities of workers, the authority that decides the work to be done, the authority that decides the time, place and approach of the work to be done, deciding how the worker will be paid and assessing whether the engagement includes corporate benefits or reimbursement for expenses - these are the aspects of a new contractor's working situation. CEST allows you to assess all of these to determine your IR35 status. To tackle tax avoidance through off-payroll working, HMRC has to identify if a person is an employee facing the income tax and National Insurance or if you are self-employed that can enjoy the tax efficiency. Therefore Self Employed IR35 rules categorise workers or contractors into two groups. They are Inside IR35 and Outside IR35 groups. Although there is no specific checklist to determine if a worker is a contractor who is self-employed or acting more like a permanent employee, key factors such as locus of control on fulfilling the contract, the possibility of substitution of work and MOO (Mutuality of Obligation) can determine if you are 'Inside IR35' or 'Outside IR35'.
Inside IR35
'Inside IR35' is like an employment contract. You are obliged to take on new work once the contract is over, which means your contract comes under MOO. You are considered for tax purposes as an employee of your end client and subject to pay as you earn when you are 'Inside IR35'. It also involves a 'deemed payment' of income tax that must be paid at the end of the tax year. You should see through that in case of a change in your working practices or the beginning of a new contract; your status is reassessed. When you are engaged in the public sector or medium & large-sized businesses, the recruitment agency or any other fee-payer becomes your 'deemed employer' and will deduct your tax and National Insurance Contributions (NICs) at the source. Therefore an umbrella Company that acts as your employer and manages contractors through payroll will be engaged as many agencies and clients will find it challenging to manage all of these.
Outside IR35
'Outside IR35' is a situation where work is completed on a project-by-project basis. Therefore, the worker may or may not undertake future work, and there is no obligation. When operating as a genuine business, you are considered to be 'Outside IR35' and therefore operating outside the IR35 rules. You can pay a salary and draw the remainder of your income as dividends when operating 'Outside IR35'. In that case, you will have to take responsibility for your taxes as usual. You may be engaged in the public sector or medium-large private sector business, but your end client is responsible for determining your status. If your end client has deemed you as 'Outside IR35', you will receive your fee without any tax deduction and will be responsible for managing your taxes as usual. You are also free to work with more than one client; there is no 'Mutuality Of Obligation' here. Despite being considered as 'Outside IR35', there are chances of an IR35 enquiry from HMRC that can extend for years.
Why does IR35 matter to contractors?
IR35 aims to remove the unfair advantage a worker engaged through a PSC has over a worker engaged as an employee under fee-payers and umbrella companies. Therefore engaging businesses will have to decide the IR35 status of the workers (contractors). In small businesses excluded from IR35, workers(contractors) will be setting their IR35 status. This finally means that IR35 can successfully combat tax avoidance by workers (contractors) and also eliminate 'disguised' employees.