Why is an IR35 review important?June 9, 2021
The latest IR35 reform – how IR35 operates in the private sector – has finally arrived, after 12 months of delay from COVID-19.
While the delay gave contractors and businesses a temporary respite from the changes, the new rules have now been in place since 6th April 2021.
With responsibility for understanding what the rules are and correctly assessing if assignments are inside or outside IR35, the impact is significant. You could be facing a change in employment and tax status, find yourself responsible for paying employer National Insurance contributions, or liable to pay fines and penalties for incorrectly categorising IR35 status.
If you haven't taken the time to consider how the changes will affect you then now is the time to do so. In this guide, we'll set out why you need to conduct an IR35 contract review, who is responsible for IR35 compliance and how you can keep up with the latest legislation.
Why is an IR35 review important?
It used to be solely the responsibility of the contractor to ensure IR35 status, yet as of 6th April 2021 this is no longer always the case. The IR35 changes this year mean that all public authorities, and medium and large businesses in the private sector, are responsible for checking if the rules of IR35 apply to a worker. Contractors will continue to be responsible for assessing any assignments with small businesses.
All contractors and businesses should review their new contracts to ensure they are compliant with IR35 legislation. Falling on the wrong side of IR35 means you could be fined thousands of pounds in additional income tax and National Insurance contributions, plus potential investigation, fines and penalties from HMRC for claiming the wrong status.
We'll review what these changes mean, but first we'll quickly recap the main details of IR35.
What is IR35?
IR35 is a piece of tax legislation brought in to prevent tax avoidance, stopping contractors who would otherwise be 'deemed employee' supplying their services through an intermediary (usually a limited company or personal service company, otherwise known as a PSC).
Also referred to as off-payroll working rules, IR35 means that if you are classed as a 'deemed employee' – an individual who works in the same way as permanent or part-time employees – then you are subject to paying income tax and National Insurance.
IR35 is really important if you are a contractor, or a business who works with contractors, as it could have a significant financial impact on you. If your written contract is deemed to be inside IR35, then HMRC views you as an employee for tax purposes.
Contractors who operate through a limited company benefit from a higher level of tax efficiency, legitimately paying less personal tax due to the nature of their contracts. However, some contractors and end clients exploited this situation.
IR35 was brought in to prevent 'disguised employees' – people who were working like a standard employee – from hiding behind an intermediary. This way of operating meant contractors could avoid paying income tax and National Insurance, and employers wouldn't have to pay employer National Insurance contributions or offer benefits like holiday pay or sick leave.
Does IR35 apply to me?
When evaluating your contract you will either be inside IR35 or outside IR35. Each contract will need to reviewed separately, whether that is a contractor dealing with end clients, or as a business dealing with individuals.
If you are outside IR35, you are operating as a genuine contractor and will not be subject to PAYE. You will maintain the responsibility of paying the correct amount of tax by your Self Assessment tax returns.
If you are deemed to be inside IR35 then the rules of IR35 apply, and you need to have PAYE and National Insurance contributions deducted from your pay each month.
At this point, you might be wondering how you work out if IR35 applies. HMRC has set out three main criteria to follow, based on the contractual relationship with your client:
Supervision, Direction or Control: How much influence does the client have on your working patterns? If you have to work on specific days or during set hours then this follows a pattern of employment.
Substitution: Is someone else able to complete the work, or it specific to you? If it is the second option then you are more likely to be inside IR35.
Mutuality of obligation: Is the client obliged to offer work and do you need to accept it? If yes, your contract likely falls within IR35.
It can be a little tricky deciding which of those applies, so let's look at some further examples.
|Inside IR35||Outside IR35|
|Your days and hours of working are controlled by the client||You can pick and choose how and when you work|
|You carry out all of the work||You can delegate work to another person|
|You work for your own limited company but receive holiday entitlement or sick leave from a client||You work for your own limited company and receive no employment benefits|
|You work at the client's premises and are supplied with equipment to carry out your role||You work from your own premises and supply your own equipment|
|You are paid on a time basis (weekly wage or monthly salary)||You are paid a set amount for a project|
|You have no marketing materials for your own company||You use your own company name/branding|
|You work with one long-term client||You work with several clients at the same time|
If the majority of one side of the table matches your situation then you should have a relatively clear picture how the IR35 rules apply to you. HMRC also has an online tool where you can put your details in to check your employment status.
There is also the option of having any contracts looked over by an accountant, an IR35 specialist or an IR35 contract review service.
Who is responsible for being compliant with IR35?
The changes to IR35 this year have brought the regulations more in line with how the public sector has been operating since 2017.
Previously, contractors were responsible for working out if they were inside or outside IR35 and paying any tax owed accordingly. The recent changes mean that now medium-sized and large business in the private sector and all organisations in the public sector are responsible for evaluating a contractor's IR35 status. If a company determines that you fall inside IR35 they must pass a record of they made their assessment, known as a Status Determination Statement.
For small businesses, it will remain the responsibility of the contractor to determine their IR35 status. A small business is defined as one which meets two or more of the below criteria:
- Annual turnover is less than £10.2 million
- Has less than £5.1 million on its balance sheet
- Has fewer than 50 employees
If you are worried about whether a company you contract for classes as small, medium or large, HMRC has made it a legal requirement for businesses to respond to information requests regarding its size.
For contracts deemed outside IR35 prior to April 2021 and then inside IR35 following the changes, HMRC will not take any retrospective action, unless they suspect serious irregularities.
Considerations for contractors
If you are a contractor then you may, understandably, be worried about how IR35 will affect any current or future contracts with clients.
You might also be wondering if it's worth carrying on contracting, or whether you should just seek permanent employment. As we've already highlighted, if your assignments fall outside of IR35 then the changes won't affect you. However, you will need to review each new assignment you carry out to confirm your IR35 status. Assessing the criteria and using the HMRC CEST tool can help to review contracts on a case by case basis.
For contractors deemed to be inside IR35, it isn't necessarily reason to panic. You can still operate through your limited company; you will just to make a deemed payment (income tax and national insurance) for contracts for which IR35 applies.
Ultimately, though, you'll want to assess how much it affects your way of working and your tax liability, but there are options you can explore. You could try and re-negotiate your rate to take in to account the additional tax you'll have to pay.
Considerations for medium and large-sized businesses
If you are a medium or large sized business now responsible for establishing IR35 status, you might be wondering how to manage this change. The best approach is to be transparent and keep an open dialogue with your end client(s).
We recommend setting up a contract review process for every contractor or new project that you hire for. Determine the circumstances for control, substitution and mutuality of obligation and ask yourself if they fall inside or outside IR35.
For both businesses and contractors alike, this process isn't always clear. If you are not entirely sure where a contract situates you, our friendly in-house team of accountants can offer expert advice and guidance on IR35.
Whilst IR35 will likely result in some changes to the working landscape, there is also still plenty of opportunity. Flexible and agile working has become more and popular over the years and many businesses depend on freelancers and contractors – likely more so as we transition into the post-COVID economy. Contractors and businesses who are well prepared for IR35 will have a competitive edge over the opposition.
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