To tax or not to tax….
IR35 is anti-avoidance tax legislation.
The latest version of this legislation was due to come into force in April 2020, but the Government delayed its introduction, understandably, as they and businesses nationwide, were struggling to cope with the effects of COVID-19.
The rules instead came into force in April 2021.
This article sets out, in general terms, when IR35 is likely to apply but it should not be read as giving legal advice. If you need advice in the matters raised, please contact Sam Dickinson on 0800 84 94 101
Background to the IR35 change
An individual in business as a contractor pays less tax than an employee if they declare to Her Majesty’s Revenue and Customs (HMRC) that their limited company (through which they provide services to clients) pays them via dividends as opposed to paying them a salary.
IR35 in its original guise (it has been around since 2000) allowed the contractor’s limited company to decide its own IR35 tax status.
This meant that HMRC was potentially losing out on millions of pounds of revenue because, more often than not, a contactor’s limited company would submit an assessment to HMRC stating the individual providing their services through the company was not in ‘disguised employment’.
This meant that payment via dividends (which do not attract National Insurance (NI) deductions and against which various business expenses can be off set) was, on the face of it, legitimate.
In 2017, IR35 was reformed with respect of those working in the public sector. This change meant it was now the public authorities that would determine the contractor’s employment status for the purposes of assessing tax. As the authorities were now responsible for doing so, they, predictively took a more cautious approach with a resulting increase in tax revenue.
When does IR35 come into force?
From 6 April 2021 it becomes the responsibility of the many end user businesses (the clients) in the private sector to assess the IR35 status of the contractors they use.
What does the IR35 change mean for employers?
If a client thinks the contractor is in ‘disguised employment’ – meaning that the contractor would be classified as an employee if that contactor was engaged directly by them - the client is obliged to deduct tax and National Insurance contributions (NICs) from all payments it makes to that contractor.
If HMRC determines that the client should have made these deductions at source but did not, it is the client that has to make the payments to HMRC and not the contractor’s company.
What does the IR35 change mean for contractors?
This shifting of risk will inevitably lead many companies to err on the side of caution, as with public authorities, and make deductions at source which in turn is likely to leave contractors feeling they are worse off.
What is disguised employment?
This concept of disguised employment underpins IR35 and a client’s assessment of whether they should be deducting tax and NI from the payments it makes to contractors.
Essentially the question being asked is whether the individual truly is a contractor or whether they are really an employee dressed in a contractor’s clothing.
The answer to that question is far from straight forward and entails an examination of what happens day to day in the working relationship and not just what the written contract between the parties says (although the written contract is important too).
If the client has control over how and when the contractor works, if they integrate the contractor into their business by providing a uniform for example, or if they provide the tools and equipment to do the job, there is a risk that the relationship will be held to be disguised employment.
If the contractor has the right to send a substitute to carry out the work, if they work for many different clients and can demonstrate that they are genuinely in business for themselves, they will have a fighting chance of arguing against their inclusion within IR35.
Who does this apply to?
Not all clients are affected by this legislation; only businesses who are medium or large organisations need concern themselves. This is defined as an organisation to whom two or more of the following apply:
- Annual turnover of more than £10.2 million
- Balance sheet total of more than £5.1 million
- 50 or more employees
How can you check your status?
Clients and contractor can use HMRC’s online tool for guidance as to status https://www.gov.uk/guidance/check-employment-status-for-tax but be warned; sometime the result is inconclusive.
Understanding the tests that HMRC will apply is important, as is ensuring written contracts point away from an employment relationship, but ultimately what happens in practice is likely to be the deciding factor.