IR35 Explained

This is a bit of a long read – but an important one.

IR35 rules took effect for small/medium sized businesses within the private sector this week (6th April 2021). It won’t apply to all small businesses as there are some qualifying criteria based on size, turnover and balance sheet value, but small businesses will need to regularly check whether they reach the criteria over time perhaps as their businesses, revenues and headcounts increase.

Background
IR35 (not the most exciting of names) is the term used for taxation rules for what we call ‘off payroll workers’. These are people who work for your organisation but not in the traditional way as an employee but as a self-employed contractor instead. IR35 is tax avoidance legislation and aims to increase tax revenues from those who work as contractors and therefore avoid tax and NI through PAYE, who really are for all intense and purposes an employee and should be paying tax and NI through PAYE.

IR35 took effect in 2017 in the public sector and in the following tax year the HMRC netted an additional £550 million in revenue, so it is clear why they are interested in rolling this out to the private sector. The new IR35 rules were due to come into force for the private sector in April 2019 but were delayed for further consultation and as a result of the pandemic. Many of us had hoped it would be delayed further or even scrapped, but no such luck. And with such a financial hole in the UK economy following the pandemic it’s not surprising it has come into force now.

Engaging contractors has had benefits for both companies and contractors. For individual contractors, depending on how they pay themselves there are tax savings to be had and in some instances they don’t pay NI. They also offset some of their expenses against tax and can work for different clients. Companies save on the employer NI contribution which saves 13.8% on salary, no employer pension costs saving a further 3%, no employee benefits costs, and there is of course flexibility and no mutuality of obligation (long term commitment), if you want to let a contractor go or increase/decrease the work you can (as long as the contract allows).

IR35 is a bit complicated, and I will do my best to try and simplify it, but if you are in any doubt about whether it applies to your business please do get in touch, it might be easier to chat through.

Does IR35 apply to my business?
IR35 rules will now apply to medium sized businesses as defined in The Companies Act. Do you:

Employ more than 50 people (on your payroll)?
Have a turnover of more than £10.2 million?
Have a balance sheet of more than £5.1million?

If you have answered ‘YES’ to two or more of these questions, then IR35 rules will apply to your business and you will be required to assess the status of your contractors.

IR35 Rules Do Not Apply to My Business
Yippee! Whilst this might not apply now it wouldn’t be surprising to see the threshold for this reduce and more companies being affected, but for now that is not on the horizon. It would be beneficial to review the three qualifying questions above regularly to ensure you don’t creep over the threshold limits, and unfortunately it doesn’t mean that you are completely off the hook. If you don’t meet this criteria for IR35 but you do engage contractors who only work for you, work very set patterns or work every day just like employees then you still need to consider whether these contractors would be deemed to be employees if you were audited by HMRC under the usual checks on employment status, irrespective of IR35.

IR35 Rules Apply to My Business – Now what do I do?
OK, so now we need to look at how you engage contractors and make a determination on their status. IR35 rules specifically concern themselves with contractors that work through a Personal Service Company (PSC) which means they set up a limited company and are probably the only office holder for that limited company. Your business engages with, receives invoices from and pays the limited company, and the individual takes either a salary and/or dividends from their limited company, sorting their own self-assessment and corporation tax.

If you engage contractors via their limited company (aka a personal service company PSC) IR35 may apply and you may need to pay NI and tax via PAYE for them moving forward – subject to a status determination.

If you engage contractors that are sole traders who deal with their own tax affairs through self-assessment and don’t operate as a limited company/PSC, then they will be classed as outside of the IR35 rules and you won’t need to pay NI and tax via PAYE moving forward (but again usual employment status checks apply.

If you engage contractors via an agency, the IR35 rules will apply to the agency and not your business, the agency will need to comply with the new rules. For your business this may mean the cost of anyone you engage through the agency might increase because the agency may be required to pay tax and NI for the contractors, but you won’t need to make the determination on status.

What’s Changed?
The biggest change to the IR35 rules that took effect on 6th April is who makes the determination of status for the contractors and for the tax liabilities. Previously, the contractors themselves would be responsible for determining whether they fall inside (need to pay tax and NI) or outside (don’t need to pay tax or NI) of the IR35 rules and they would tell their clients. From now on that burden has been switched to the company/client. Qualifying companies/clients are now responsible for auditing and assessing any contractors they engage with to determine their IR35 status and whether they fall inside or outside of the IR35 rules, and there are specific actions and steps you will need to take to assess this.

One of the biggest concerns with this big shift in responsibilities is that contractors may not agree with the determination made by their client and so it may cause conflict and you may lose contractors, it may also put the cost of working with your contractors up, because they will probably increase their rates to cover any deductions you make, if you have determined they fall inside IR35 and start deducting tax and NI from their fees. This could also open the door to more tribunal claims (such as those seen in cases such as Uber) where those assessed as being inside IR35 rules look to claim holiday pay, sick pay and other benefits and employee/worker status.

How Is Contractor Status Considered?
The key question we are required to ask is:
“If you engaged this person directly (not through a personal service company aka Ltd Co) would they be an employee?”

If the answer is yes then they are for all intense and purposes an employee and IR35 would apply – subject to a status determination.

However, the way a contractor is assessed depends on a lot of different things, which is why it is complicated and why you should keep records of your decision/rationale, here are a few examples to give you an idea of why your rationale is so important:

• Supervision, control and direction – do you have the main say in what your contractors do, how they do it, when they do it and where they do it – if you are in control of all of these things and the contractor has little say then they are most likely an employee in reality and fall inside IR35 rules.
• Substitution – does the contractor have to provide the service personally or can they substitute someone else if they are unwell, away or unavailable. Can the contractor freely choose the substitute or do you choose the substitute. If the contractor can freely substitute and they aren’t the only one who can provide the service, then they probably fall outside of IR35 rules.
• Mutuality of obligation – what is the commitment between the parties, does the contractor have to accept the work given by you and do you commit to always give certain hours/work very regularly, if so the contractor probably falls inside IR35.
• Does the contractor work for other clients? If they do they probably fall outside of IR35.
• Integration – how is the contractor integrated as part of the team, are they treated like an employee and included in everything such as social functions, use of canteen and facilities, able to come and go freely with their own building pass, do they sign in and out as a visitor, are they provided with car parking or bike storage, do they have an email account/address in your company name, do you give them business cards for your company, do they hold themselves out as employed by your company etc. if they are/do these things they may be an employee in reality and fall inside IR35.
• Do they provide/use their own equipment or do you provide any equipment to them, if they provide the equipment they may fall outside of IR35.

As you can see, it isn’t straight forward and a status assessment will consider lots of different aspects to come to an overall determination.  It is this subjectivity which is expected to cause confusion and disagreements.

What Action Do I Need To Take?

There are a number of things you need to do to ensure you comply.

1. Carry out an audit across your business to identify and review all engagements with contractors.
2. Determine each contractor’s status and whether they fall inside or outside of the IR35 rules. You could use the government assessment tool CEST (Check Employment Status For Tax) to help you – feedback received to date suggests that whilst this is helpful it but can be very subjective and often declares it cannot clearly determine status, so you may not be able to rely on this tool alone and this is why making notes and keeping records of how you came to your decision is so important.
3. Provide a ‘Status Determination Statement’ including any rationale for your decision to each contractor. Be prepared, they may not agree with your determination and you may need to justify your rationale to them.
4. Create an appeals process for contractors to appeal your status determination, should they disagree. Advise them of this process should they wish to use it. If you engage a large number of contractors, you may wish to create a ‘Handling Contractor Status Determination Assessments Policy and Procedure’.
5. Diarise to review contractor status regularly.
6. Keep good records of your assessments and fees paid to contractors (and HRMC where appropriate) and the rationale behind your decisions for a minimum of 6 years.

How Can Metro HR Help?
If you need some assistance with determining the status of your contractors we can help with workforce audits and reports, creating, updating or reviewing policies and procedures and can give adhoc advice as you work though the process. We offer a free 30-minute consultation which you can request via www.metrohr.co.uk or contact us at [email protected]