What is IR35?
IR35 is not new. Announced in 1998, mooted in 1999 and finally introduced to UK law in April 2000, the legislation has since been consolidated most notably in the Income and Tax (Earnings and Pensions) Act 2003 and has, from its inception, sparked controversy.
Broadly speaking, IR35 means that when engaged via an intermediary (a limited company or personal services company (PSC), for instance) under terms and conditions that are indicative of employment, PAYE (Paye As You Earn) and NICs (National Insurance Contributions) apply to any payments received under that contract.
Since its implementation, HMRC has lost many high profile IR35 cases and disclosed that the legislation never delivered the tax revenue that was initially anticipated. In fact, it is believed by Consultancy.uk that only 10% of freelancers (limited company contractors) actually comply with their tax responsibilities under the legislation.
Up until 2017, limited company contractors were responsible for determining their tax status under the IR35 legislation. However, legislation reform in 2017 in the public sector gave responsibility to the end client for determining whether an assignment fell inside the IR35 legislation or outside, removing the burden from contractors.
Following this public sector reform, the UK government’s draft legislation for the Finance Bill 2019 spelled out plans to extend IR35 obligations to end users in the private sector. Despite trade body lobbying and industry contention, the IR35 reform, also known as the ‘off-payroll working rules’, look firmly set to make an appearance in April 2020. In fact, Guidant Global reports that the government’s latest budget suggests that IR35 will sit atop the mantelpiece, with the potential to raise £725 million in additional tax revenue by 2022-2023.
From April 6 2020, responsibility for determining whether a contract or assignment falls inside the legislation will shift from the limited company to the end client.
As of July this year, the Association of Professional Staffing Companies (APSCo), originally formed to fight the government’s very first IR35 proposals, published notifications that businesses and employers remained unprepared for off-payroll working in the private sector. Their survey revealed that only 39% of professional recruitment firms believed that the businesses they engaged with were aware of the pending changes.
Similarly, while contractors appear to be aware of IR35 reform there remain many questions, concerns and misconceptions surrounding it.
Here we attempt to cut through the jargon with a lay person’s overview of IR35.
Who does the IR35 ruling apply to?
The off-payroll rules apply if a worker provides their services to a client through an intermediary (a limited company or personal service company) but would be classed as an employee if they were contracted directly with the client.
Why was the legislation created?
The legislation aims to stop limited company contractors reaping the same benefits as permanent employees whilst also enjoying the tax and national insurance saving opportunities that come with operating via a limited company. Put simply, the government wants to align the contract workforce and the permanent workforce for a fairer deal for all.
Who will determine whether IR35 applies as of April 2020?
In the majority of cases this is the client. All public sector authorities plus any medium and large-sized private sector clients will be responsible for determining whether or not the rules apply and a worker is “inside IR35” or “outside IR35”.
Where the private sector client is considered “small”, the worker / limited company contractor will remain responsible for deciding whether IR35 applies.
What is a ‘small’ company?
Under section 382 of Companies Act 2006, a client qualifies as ”small” if two of the following conditions apply:
- Annual turnover Not more than £10.2 million
- Balance sheet total Not more than £5.1 million
- Number of employees Not more than 50 employees
Please note that the small company exemption applies to the end client, not the fee-payer or limited company. The recruitment business should inform the worker if the client is a small entity, however there is no statutory obligation to do so. Therefore, the worker must make enquiries when discussing the assignment details, as they will have the responsibility and liability to apply the off-payroll working rules when the client is a “small” company.
How is the determination made?
Status Determination Statements (SDS) should be made by the end client, however, any parties involved can check whether IR35 should apply. Determinations are made through the online HMRC curated CEST tool which can be found at - https://www.gov.uk/guidance/check-employment-status-for-tax.
Inside or Outside IR53?
Under current guidance, for an assignment by a limited company contractor to be considered ‘outside IR35’, a number of conditions need to be met.
- Independence / control: The client does not supervise, direct or control how the contractor delivers the services. Further, consultants must not be treated as employees and should not receive the same benefits as employees.
- A right of substitution: The consultant can provide a substitute if he/she is unable or unwilling to do the work and the client has no right of veto as long as the substitute has the right skills/qualifications. This needs to be something that can be practiced in reality and not just written into an agreement.
- Non-exclusive: Nothing in the contract should prevent the contractor from performing paid work for more than one client concurrently.
- No mutuality of obligation: During an engagement, there is there is no obligation for the consultant to provide any services outside of those documented on the Statement of Work. Similarly, at the end of the contract, there is no obligation for the client to offer more work to the consultant and if more work were offered, there is no obligation for the consultant to accept such work.
- Financial risk: Consultants should demonstrate some financial risk around delivery of the services – e.g. if rework is required, it should be done at the consultant’s own cost and expenses.
**These are not absolute, and the best test of whether an assignment falls inside or outside of the legislation is the CEST tool, managed and curated by HMRC.
What does the determination mean?ASSIGNMENTS OUTSIDE IR35
When the client makes the status determination that an assignment is “outside IR35”, they must ensure that “reasonable care” was taken during the decision-making and that the decision itself is reasonable. If the client does not exercise reasonable care, the status determination statement will not be valid, and the client will be liable for the unpaid taxes.ASSIGNMENTS INSIDE IR35
If the client determines that an assignment is “inside IR35”, then the worker will need to understand what options are available in terms of an alternative to an off-payroll model. The alternative pay options are:
- PAYE payroll (agency/temporary worker). A recruitment business can contract directly with the worker and make tax and NICs deductions at source.
- Umbrella Company - If you engage an umbrella company, they will make tax and NICs deductions at source.
- “Inside IR35” PSC / Limited Company – Should you wish to continue to engage as a contractor via your limited company who is deemed “inside IR35”, your recruiter will need to calculate a “deemed employment payment” using the RTI (Real Time Information) payroll system. The deemed employment pay rate is the income of the worker after deductions, including both employee and employer NICs and the Apprenticeship Levy. Neither worker rights nor stakeholder pension rights apply. No expenses allowance applies.
What does this ultimately mean for the contractor?
Where IR35 is applicable and the client makes the status determination, the contractor’s payments will be subject to PAYE tax and National Insurance Contributions. These deductions will be levied by the “fee-payer” which is the entity who holds the contract with your limited company, typically this is the recruitment business.
If your assignment falls “inside IR35”, the take-home pay will be less as the recruiter has a statutory duty to deduct the appropriate tax and NICs. Be aware that historically, PAYE rates have always been lower than PSC rates so you may find that in future pay rates offered are lower.
What if you get it wrong?
If the off-payroll proposals are legislated in their current form, where HMRC disagrees with the determination made, it can investigate and insist on back payment of tax, as well as fines for late payment from the fee-payer.
How will it impact hiring?
This is speculative but a glimpse into the future has suggested impact in a handful of areas:
Rates - Many clients are not offering increases in pay rates or bill rates to offset National Insurance Contributions (NICs) meaning workers will directly be burdening the cost. Whilst this is perhaps more applicable to an incumbent workforce who are having to change the way they engage with the client or work as off-payroll part way through an assignment, it could also impact future hires and their rates. There is little sympathy being shown on the part of big business and, ultimately, their budgets are the dictators. Will the high pay rates of the limited company contractor workforce slowly become a thing of the past?
Timelines - Time to hire may be impacted, especially in the early stages of reform. Many recruitment agencies and managed service providers are having to overhaul their procedures with clients to ensure compliance with IR35 and subsequently, it’s likely there will be bumps in the road and ultimately, delays in getting contractors into roles. Equally, the right to dispute the client decision may also result in hold-ups. Clients are required to provide a status determination statement when releasing a role. If this takes time to produce or there is uncertainty, roles could take longer to be advertised, sourced and filled, impacting end clients.
Industry - The past year has seen a gradual shift from limited company contractors to PAYE. We can only presume that as HMRC has reduced the benefits available to limited company contractors, IR35 reform in the private sector has come to the fore and end clients have chosen to reduce risk the limited company or PSC option has become less widely utilised. Currently Aquent’s working PAYE candidate base is greater than that of its limited company contractor base for the first time in years. Will IR35 reform continue to encourage this shift towards a PAYE model? Will limited companies become few and far between as time wears on? Will a reduction in limited company contractors change the nature of the contracting landscape in the future? Will a risk averse client base mean more fixed term contracts and perm opportunities? Will the career contractor become a thing of the past? We have to wait and see.
I move from role to role and never stay anywhere too long so will I be impacted by IR35?
The end client is not making a status determination on the worker, they are making the determination on the nature of the assignment. Whether you are working for three days or three months your assignment will be assessed and will be considered either inside or outside of the legislation accordingly.
I have been working in the same role at the same client for years, will HMRC investigate me if I am suddenly paying tax and NICs?
This is a question or discussion for contractors and their financial advisors/accountants. Freelancer/Contractor non-compliance with existing IR35 legislation is on a large scale. HMRC are reportedly making changes to increase future tax revenue and realise the financial benefits of the tax legislation, rather than penalise retrospectively. There has been much talk that HMRC does not have the manpower to investigate every contractor that suddenly falls inside legislation. This would be a task of epic proportions. How HMRC will proceed in reality is yet to be seen.
How do I know that a recruitment agency is compliant with legislation?
There should be a number of key pointers that allude to a compliant, IR35-aware agency. Vacancies should always be advertised as inside or outside of the IR35 legislation - this should be your first pointer suggesting that an agency knows what they are doing. Recruiters should be raising IR35 as early on as possible in talks about roles. Any assignment schedules, contracts or booking confirmations you are issued should clearly show whether your assignment is inside or outside the legislation. Status determinations made by the client and reviewed by the agency should be available to you if asked. It’s likely that an agency will have a specialist (or someone well versed) working for them, who you can be directed to for any queries.
What if I disagree with the status determination made by the client?
Contractors are entitled to challenge the determination that the end client has made, by formally challenging with the recruitment agency. This challenge should be made where the contractor believes the reality of their working situation has not been accurately reflected during the decision making process and should not necessarily be a reaction to what the contractor sees as an unfavourable decision. The agency and the end client are expected to have a challenge or dispute procedure in place to facilitate this. The end client has 45 days to respond to the dispute with their decision and paperwork. It’s important to remember that the client may uphold their original determination.
Can I leave and work in a role that is outside of the legislation?
In all likelihood the majority of roles released and advertised will fall inside the new legislation and subsequently be subject to the off-payroll working rules. Leaving your current role in the hope of finding another that falls outside of the legislation may be a mammoth task.
What is Aquent’s position on IR35?
Aquent recommends liaising with your accountant or financial advisor regarding the reform so that you can be best prepared for any changes.
We can confirm that Aquent will still continue to work with limited companies who fall inside legislation by paying them as 'off-payroll'.
However, it is important to note, that Aquent does not make any decisions regarding IR35 and whether an assignment falls inside or outside of the legislation. The end client always makes this determination. Many businesses are currently reviewing their incumbent workforce and determining how they wish to proceed.