The UK government’s proposed changes to the so-called “off-payroll” working arrangements is intended to close loopholes used by businesses and workers to reduce the administrative burden of formal employment and tax liabilities.
HMRC has estimated that only one in ten contractors in the private sector were paying the correct tax.
Changes to the IR35 rules, it says, could bring in close to £3bn over the next four years. The reforms will have a significant impact on the approximately 230,000 contractors currently operating within the UK. The deadline for the changes was originally set as 6th April 2020. However, due to the coronavirus pandemic, the deadline has been extended to 6th April 2021.
Organisations representing self-employed contractors have been lobbying against what it considers to be unfair and unduly onerous rules affecting their members. However, at the time of writing, the government has not indicated that there will be any major changes to the rules.
The changes to the IR35 rules involve the intersection of two notoriously complex areas of law namely tax and employment. The purpose of this article is merely to explain some of the key concepts informing the change and how it may be implemented. If you believe that you or your business may be impacted by the IR35 rule changes we strongly recommend that you take specialist advice.
Is IR35 new?
No. The IR35 rules have been in place since 2000. HMRC determined that, on close examination of the day-to-day working arrangements, a large number of “self-employed contractors” were actually “disguised employees”. Employers were using this system to reduce the administrative burden of a larger payroll. Contractors benefitted from a lower tax bill particularly in regards to National Insurance Contributions.
HMRC seeks to ensure that everyone is paying the correct rate of tax. If the working relationship is deemed to be inside IR35 then the end-user client (or the entity paying the contractor) must deduct tax at source (PAYE) and pay the balance to the contractor. If the working relationship is outside IR35, then the gross amount is paid to the contractor who will file their own tax returns and pay the applicable taxes.
So, what are the changes to IR35?
The significant change that was due to take effect on 6th April 2020, but which has now been extended to 6th April 2021, is that the responsibility for determining whether an employment relationship was inside or outside IR35 has shifted from the individual taxpayer to the end-user client (alternatively the entity paying the fees of the contractor).
This is significant because, under the current dispensation, the status determination is made by the taxpayer. Under the new rules, the status determination (ie inside or outside IR35) must be made by the end-user client (alternatively the entity paying the fees of the contractor). If HMRC decides that the incorrect status was applied the end-user client could become liable for back taxes, penalties and interest on arrears.
In addition to the financial consequences, a business could face severe reputational damage for essentially being complicit in tax evasion which may affect its professional standing if it operates within a highly regulated environment like banking or the legal profession.
How is a status determination made?
If the business is engaging self-employed contractors then an individual status determination must be made in respect of each contract. The business must:
- Apply a reasonable and fair process for making a status determination;
- Provide the contractor with a written document containing the status determination and the reasons for such a determination.
HMRC has provided a tool on its website to assist employers in making the determination. It asks a series of questions to determine whether a specific contract falls inside or outside IR35. HMRC has, as a matter of official policy, stated that it will be bound by the status determination generated by its online tool provided that the information given is correct. While useful, the tool has been criticised as being somewhat unreliable and skewing towards determinations which result in an “inside” IR35 status.
What is a status determination?
The status determination process seeks to determine whether there is an “employment relationship” between the parties. If there is an employment relationship then the end-user will be responsible for deducting PAYE tax. Please bear in mind that a status determination of an employment relationship for tax purposes does not necessarily mean that there is an employment relationship for the purposes of employment law. This is, in fact, one of the major objections raised by contractors that they may end up being taxed like employees but with none of the consequent statutory benefits.
What is an “employment relationship” for the purposes of IR35?
There are no hard and fast rules for making this determination. HMRC has, in its guidance notes, set out a number of factors what would indicate the existence of an employment relationship. It is strongly emphasised that this is not a “box-ticking” exercise and care must be taken to evaluate the overall effect of the contractual arrangement between the parties. These are the factors to consider when making a status determination:
- Mutuality of obligation – does your contract require you to provide additional work to a contractor outside of the original scope of the project? Are they required to accept that work?
- Substitution – is the contractor able to substitute themselves with another worker? This is will be given less weight if, for example, the contractor is providing highly skilled services;
- Supervision and control – does the contract require a worker to adhere to the company policies for example working hours? Does the contractor report to the company and, if so, to what degree? Does the contractor supply their own equipment?
- Part and Parcel – is the contractor part of the management structure of the company? If they have line manager duties or sit on committees or even the board, this could indicate that they are an employee and not an independent contractor.
Do these changes apply to all businesses?
No. HMRC has exempted what it deems to be “small” businesses from the requirement to make an IR35 status determination. A business will be regarded as “small” if at least two of the following apply:
- annual turnover is less than £10.2 million;
- the balance sheet indicates assets of less than £5.1 million;
- there are fewer than 50 employees.
Please bear in mind that IR35 rules still apply even if you are contracting to small businesses. If you are a contractor and during the course of an HMRC audit it is determined that your status was actually an employee, you may become liable for arrears of taxes. It is not a defence to say that you were working for a “small” business.
What does this mean for contractors?
Unfortunately, it does appear that the major tax advantages of being a self-employed contractor may be gone for good. A large majority of self-employed contractors work through limited companies styled as a “personal services company” or PSC. Many of the large banks' other employers, who engaged contractors using PSCs, have indicated that they will not enter contracts with PSCs in the future.
While there will always be a need for short term staff within an organisation these arrangements may be made on the basis of fixed-term contracts (with PAYE). If you believe that your contracting work might be affected by these changes it would be prudent to obtain independent tax advice.
This article is provided by Burlingtons for general information only. It is not intended to be and cannot be relied upon as legal advice or otherwise. If you would like to discuss any of the matters covered in this article, please contact Gary Green or write to us using the contact form below.