The government has introduced changes to IR35 legislation on 6th April 2021 – a year later than originally planned due to the Covid-19 emergency. What do contractors or hiring businesses need to do to ensure their businesses are meeting the new rules and requirements?
We’ve written a number of articles around the subject of IR35, including ‘Who is responsible for making IR35 status determinations and paying employment taxes?‘ and ‘How to tell if your assignment (contract) is inside or outside IR35’.
This article will focus on how contractors working through their own personal service company (PSC) can get their businesses ready for the IR35 changes.
Let’s kick things off with a little background information, just in case you haven’t read our other IR35 articles.
IR35 is not a new tax: in fact, the off-payroll working rules, also known as Intermediaries Legislation, was introduced in 2000. The original press release announcing the rules was entitled Inland Revenue budget press release number 35 – hence the rules became known by the name IR35. The rules are intended to ensure that contractors working through an ‘intermediary’ – usually a personal service company – pay broadly the same income tax and National Insurance Contributions (NIC) as an equivalent employee.
HMRC believes that many private sector contractors, potentially up to 90%, are in fact ‘disguised employees’ and are incorrectly describing their employment status as ‘self-employed’. There can be significant differences in the taxes paid between someone who is self-employed and employee.
HMRC has said that it wants to ensure a level playing field, so that you cannot have two individuals working side-by-side doing a very similar job but being taxed differently, one as an employee and one as a self-employed contractor. HMRC have also said they believe this could affect up to 170,000 individuals working through their own limited company.
When do the IR35 rules apply?
HMRC has said: “The rules apply if a worker provides their services to a client through an intermediary, but would be classed as an employee if they were contracted directly.”
Although the rules can be complicated, we’ve tried to simplify how to tell if you’re affected. If the following apply to a contractor’s assignment, then IR35 rules must be considered:
- The contractor personally performs the work for a client
- An ‘intermediary’ is used, such as a personal service company (PSC) or recruitment agency, which means the worker is not contracted directly to the client (the rules do not apply to sole traders)
- If the worker was contracted directly to the client, they would be regarded as an employee of the client for tax purposes.
Before April 2017, workers operating via a PSC were responsible for determining whether an assignment was inside or outside IR35 and for paying any employment taxes due. However, in 2017, these rules changed in the public sector, which meant organisations such as government departments, local authorities and NHS Hospitals, (and not PSCs) became responsible for assessing the employment status of their contractors and paying any employment taxes due.
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IR35 – What changed from April 2021?
We have a detailed article on who determines your IR35 status and pays the employment taxes, but in summary:
On 6th April 2021, the changes made in 2017 to the public sector were be extended to apply to the private sector. Since that date, medium and large-sized private sector businesses are responsible for determining the employment status of a contractor’s assignment, deducting any employment taxes due and paying any tax owed to HMRC.
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Small business exemption to the new IR35 rules
There’s 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 under £10.2 million
- Balance sheet total is under £5.1 million
- Under 50 employees.
Where the end-client meets two or more of these criteria, responsibility for determining the IR35 status of an assignment remains with the PSC, the changes do not apply.
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Status Determination Statements (SDS)
One important requirement being brought in by the new rules is the end-client must confirm the IR35 status of an assignment by providing a ‘Status Determination Statement’ (SDS) to the PSC worker. If an agency is involved in the labour supply chain, the agency must also receive a copy of the relevant SDS.
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Overseas clients and IR35
The new rules apply to all UK tax resident workers. If the end-client and any agency involved is an overseas business with no UK presence, then the new rules would not apply and the contractor would remain responsible for deciding their IR35 status and making any deductions necessary. This is a complex area and advice always should be taken from an accountant or tax expert based on an individual’s circumstances.
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Why do contractors want to be outside of IR35?
There are a number of reasons why contractors wish to remain outside IR35. They may believe they’re truly self-employed and wish to continue to be able to choose the assignments they work on, rather than be forced to become employed. Individuals also seek the freedom to work with multiple clients and do not want to be tied to a single end-client for regular work.
Many self-employed people operate their own limited companies and enjoy the flexibility and lower taxes involved in taking income from their companies by paying a combination of a tax-efficient salary and dividends. Limited companies can also claim various expenses to reduce the amount of Corporation Tax payable and tax relief may be available when an individual decides to close their limited company.
In addition, being inside IR35 for an assignment may result in a reduction in take-home pay for many contractors if they cannot negotiate an increase in their day rate to accommodate the higher employment taxes paid when an assignment is inside IR35.
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Does IR35 mean the end of contracting?
We don’t believe it does. Whilst there will undoubtedly be many contractors who decide that they are prepared to become employed, or that they’re happy to work through an Umbrella company, the potential downsides mean that many contractors will choose not to take contracts from businesses who only offer these options. As mentioned above, the reduction in take-home pay will be a key fact, although an employed position may come with additional benefits such as holiday pay and pension contributions. This may not make up for the loss of flexibility.
Undoubtedly, there has been a lack of understanding and clear guidance from HMRC to contractors in the past which has led many to incorrectly believe they were outside IR35. HMRC stated that they estimated only 10% of contractors were classing themselves as inside IR35, and that incorrect assessments amongst the remaining contractors may cost the treasury up to £1.3bn a year by 2023-24. Accountancy Age has reported that HMRC’s target is for around a third of all engagements being classed as inside IR35. If this is the case, there would still be a huge market of contractors correctly working outside IR35 on assignments.
Contractors who are now deemed to be inside IR35 will need to decide whether they are willing to accept the impacts and continue working for their client, either as an employee or through an Umbrella. But often small adjustments to contracts, including clear statements of work and clarity over working practices, can mean that an assignment can be altered so that it is outside IR35. There are benefits to both end-clients and contractors to do so if possible, both in terms of workforce flexibility and in terms of tax savings.
In October 2019, ahead of the originally planned introduction date, many medium or large-sized businesses issued statements saying they would no longer work with PSCs. Others have since said that all their assignments are ‘inside IR35’ and have directed workers towards Umbrella companies or even offered them PAYE positions, either permanent or fixed-term contract positions.
This blanket approach is potentially expensive for end-clients who could risk being liable for taxes and fines if the decisions are challenged, and are clearly not what HMRC are saying is acceptable. Ultimately though, an end-client has the right to decide what assignments they make available and how they fill those positions. But, they may find it difficult to attract the right contractors if they do not increase their rates, which would be damaging for their business in the long term.
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Key factors affecting your IR35 status
The best way to evidence your assignment is outside IR35 is to ensure your contract, and the working practices you follow with your clients, show you are an independent contractor and not a ‘disguised employee’. HMRC will ‘look beyond’ your contract towards your working practices if they query the IR35 status of an assignment.
There are three key principles that will determine your assignment’s IR35 status, as shown below.
Supervision, Direction and Control
This principle considers the degree of supervision, direction, and control your client has over what, how, when, and where you complete your day-to-day work. If your client tells you how to work, the hours you must work or where to perform your work then it’s likely your assignment is inside IR35.
You can evidence that an assignment is outside of IR35 by agreeing on a clear set of project deliverables with your client for the duration of the assignment. Do not take on other work for the client or let yourself be moved onto different projects that are out of the scope of the original contract terms. You should also ensure your contract clearly states the services your company (and not you personally) will provide.
The second principle examines whether you are required to carry out the work yourself and whether you can send a substitute to perform your work.
Your contract with the client should be in the name of your limited company and should contain a clause allowing your company to send a substitute. However, the right to substitution must be genuine, and must not be so restrictive that your client could reject any substitute you provide. The client may, of course, satisfy themselves that any substitute is suitably skilled and qualified and passes any security clearance requirements they might have.
Mutuality of obligation
Finally, this third principle looks at whether your client is obliged to offer you work and whether you are obliged to accept any work offered to you.
Mutuality of obligation is often difficult to evidence one way or another. All assignments will have a minimum expectation of work to be completed and when it is due to be paid for by the client. A self-employed worker will not expect to be offered work beyond the contracted assignment and would not (contractually) be required to accept any work offered. You should not have a long notice period or any termination clause in your contract. Such clauses may indicate an obligation on the part of the client to provide you with work, and your part, to deliver that work.
Other factors affecting your IR35 status
There are a range of other indicators about the IR35 status of an assignment. The list is not exhaustive and constantly changes based on IR35 cases examined by HMRC. If you are self-employed you shouldn’t:
- Be identified personally on the client’s organisation chart or internal list of employees
- Wear an ID card with your name and the client’s name on it. You may have a pass or ID card but these will identify you as an independent contractor and your company, they won’t suggest you are an employee of your client
- Need to attend meetings about HR matters internal to your client
- Be required to take part in any appraisal or performance management process for you personally or any of your client’s employees.
You shouldn’t be entitled to time off for sickness absence or holidays or to share options or bonuses which are the same as your client’s employees. Your contract may, of course, have an incentive for effective completion, but that must be distinguishable from any arrangements your client has for direct employees.
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Actions you should take to ensure you comply with the new IR35 rules
It’s essential you understand the approach taken by your clients towards IR35. You may be able to work on a combination of assignments, with some being inside and some being outside IR35. You can use our free online IR35 Calculator for contractors to get an accurate indication of the IR35 status of your assignment.
Your clients may accept evidence from you about your self-employed status and to inform the SDS they produce. Some good indicators you are not an employee include:
- Having your company own website and business e-mail address
- Holding appropriate small business insurance
- Being VAT registered
- Having business cards, marketing brochures, flyers, etc. for your business
- Using your own equipment on projects
- Having your own business address/office (even if it’s at your home).
You should also ensure your marketing materials promote your business and not you personally. It may be helpful if the name of your limited company does not include your own name, i.e. ‘Business solutions limited’ would be better rather than ‘Joe Bloggs solutions limited’.
It may also be helpful to make sure that any online CVs or personal profiles on social media represent you correctly as a contractor, with your own business rather than as an individual, which means:
- Talk about your ‘professional experience’
- Mention your status and company name and business e-mail address
- Describe how you can deliver benefits to a client’s businesses
- Have ‘recommendations’ about your business rather than personal ‘references’.
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What if your client determines you are inside IR35?
When your client pays you after April 2021, and the assignment is deemed to be inside IR35, the client will be responsible for deducting the necessary income tax and NIC and pay this over to HMRC. They must also provide you with a Status Determination Statement (SDS) that confirms the assignment is inside IR35. Your Take-Home Pay will be reduced unless you have negotiated a higher contract rate.
It’s possible to continue working through a limited company even if your assignments are deemed to be inside IR35. It’s important to remember that IR35 status is based on each individual assignment. So, if you’re working on a number of assignments, some ‘inside IR35’ and some ‘outside IR35’, you need to make sure you have the right accounting processes in place.
Our Crunch Premium package is ideal for this situation, as it includes the ability to work through a limited company for assignments outside IR35, or through a compliant and hassle free Umbrella company for assignments inside IR35.
Crunch can also help with making the correct deductions if you are working inside IR35 for a client that meets the small company exemption. Or, if the assignment your working on is inside IR35 and your end-client is responsible for determining your employment status and pays your limited company after the deduction of employment taxes, you can use your Crunch online accounting software to record the necessary payments and deductions.
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What if you don’t agree with your client’s IR35 assessment?
It’s good practice to be involved in your client’s status determination process, but there is no statutory right for a contractor to be consulted. HMRC has stated that businesses must take reasonable care over the status assessment and that blanket status decisions should not be made.
Your client must establish a formal process to consider any disagreements. The client will receive your appeal and decide whether to uphold it or not. The whole process is ‘client-led’. Disputes must be responded to in writing by your client within 45 days of receiving notice that you disagree with an assessment.
Carrying out your own status assessment using our free online IR35 Calculator for contractors would be a good starting point before considering an appeal. The initial result is free and you can upgrade to a detailed report with an analysis of your areas of risk for IR35. The report should be useful if you need to dispute the status assessment made by your client.
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What if your client ignores IR35 or won’t apply the rules?
If your client doesn’t apply the rules correctly, or fails to take reasonable care in preparing an SDS or doesn’t prepare one at all, HMRC might still decide the assignment is inside IR35. This means the client would be liable for and must pay the relevant amount of income tax and NIC to HMRC. Your client may also risk financial penalties or even the possibility of a criminal conviction for their failure to apply the rules correctly.
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How Crunch can help your contractor business
With over 10 years’ experience in the contractor accountancy market, Crunch can help you navigate the IR35 maze. We have a range of information, guidance, and advice on our IR35 Hub, as well as an IR35 calculator that lets you understand whether you’re at risk of being caught by the new rules.
We also offer a range of IR35 solutions for limited companies as well as a hassle-free Umbrella Service if you’re working on contracts that are inside IR35. Our Premium package lets you combine both limited company and Umbrella services if you’re working on a combination of assignments both inside and outside IR35. Speak to an advisor today on 0333 920 4791 to see how we could help.