New tax rules for freelance contractors and their clients came into force in April 2021. IR35, or ‘off-payroll working rules’, have caused confusion for contractors and the businesses that hire them. Sole traders are not affected, but any worker providing services through an intermediary such as their own limited company – also called a Personal Service Company (PSC) – will have been following the changes closely.
As with any major shift in tax legislation, it can take a while for the implications of the new regulations to become clear. And as HM Revenue & Customs (HMRC) continues to update its guidance, many questions still remain, for example around the issue of employer National Insurance contributions and who will ultimately pick up the tab for this additional tax burden when a contractor is deemed to be ‘inside IR35’.
Here are the basics behind the IR35 regulations, who it affects, and how to manage the transition to an ‘inside IR35’ status.
What does IR35 stand for?
It may sound like a top secret codename, but there’s a simple explanation behind the term. Back in the days when HMRC was called the Inland Revenue, a press release addressing the issue of tax avoidance by PSCs was issued. This was the 35th Inland Revenue press release of the 1999 budget, hence IR35.
What is the thinking behind IR35?
When individual contractors provide their services via a limited company, or PSC, there is a potential tax benefit both to themselves and to their client. Typically, the contractor can save on Income tax and NI contributions by receiving income in the form of a modest salary, topped up with dividends. Most of their tax is paid as Corporation tax, which currently stands at 19%.
For employers, there is no obligation to provide a contractor with a workplace pension, nor to pay Class 1 employer NI contributions at the current rate of 13.8%.
If certain conditions are met and the contractor is ‘outside IR35’, it’s perfectly fine to work in this way. However, if the contractor is essentially an employee of their client – just being paid in a different way – the Treasury is clearly losing out on a valuable stream of tax revenue.
IR35 exists to ensure that these ‘disguised employees’ are taxed at source via the usual PAYE system, and that employers pay the relevant NI contributions for their workforce.
Who is affected by IR35 regulations?
Any contractor who provides services to a third party, whether working for the public or private sector, should be assessed for IR35 purposes. Previously, it was down to the contractor themselves to decide whether they were a ‘disguised employee’ and should therefore be taxed in the same way as any other staff member. However, from 2017, public sector authorities became responsible for making that decision, and since April 2021, medium-sized and large clients in the private sector (including charities) must decide on their contractors’ IR35 status.
Where a contractor is working for a smaller business, it remains the contractor’s responsibility to decide on their own employment status. To qualify as a ‘smaller business’ for IR35 purposes, companies must meet two or more of the following conditions:
- An annual turnover of less than £10.2 million
- A balance sheet total of less than £5.1 million
- Fewer than 50 employees
Inside or outside IR35 – how is the decision made?
There are various tests that must be applied to determine a contractor’s status. Confusingly, the guidance on this is far from crystal clear, with new case law precedents being set as decisions are challenged at HMRC tribunals.
Where it’s up to the client to assess status, they must outline their decision, and reasons behind it, in a Status Determination Statement (SDS) sent directly to the contractor. The contractor has the right to challenge the SDS.
HMRC provides an online status checker tool, CEST, however its conclusions are not always definitive, and it is highly advisable to seek expert advice from an IR35 tax specialist to discuss the CEST results.
Broadly, a contractor may be deemed to be inside IR35, i.e. an employee in all but name, if the following conditions apply:
- You are required to provide your personal service – you and no-one else will do the work i.e. you cannot send a substitute to work on your behalf.
- You are controlled in the manner in which you do the work, i.e. you must be at a certain place at a certain time, rather than work according to your own schedule.
- Mutuality of Obligations exists, i.e. there is an expectation that work will be offered by the client, and you are obliged to accept it.
Sounds simple? In reality, this is a nuanced area of tax law that continues to evolve.
What to do if your contract has been classed as inside IR35
Many contractors may simply decide to do nothing, and accept that their pay cheque will now land in their company bank account minus the usual PAYE deductions. It’s vital to remember, though, that they will be treated as an employee for tax purposes only – they will not receive other employee benefits such as holiday or sick pay.
Crucially, employers are NOT able to pass on to the contractor the additional costs that they incur, namely Class 1 employer NI contributions. But while this is clearly legislated against, there has been much concern amongst contractors about the issue of ‘indirect recovery’, whereby employer NICs are clawed back by paying lower contract fees. Umbrella companies and agencies are under scrutiny for passing on these costs to the contractor, with a group action currently underway.*
The message is: check your contracts and your remittance advice very carefully, and always discuss any concerns with a tax expert. Remember that IR35 should be considered on a contract-by-contract basis: some contracts may fall within the scope, some may not, depending on the nature of the working relationship.
If you disagree with the Status Determination Statement you’ve been given by your client or agency, seek advice at the earliest opportunity. IPSE is a not-for-profit organisation for the self-employed, and its website has a dedicated IR35 section. For a detailed insight on the status of your company’s freelance contracts, speak to an accountant with IR35 expertise.
