IR35 stands for ‘Inland Revenue Press Release no. 35’, which was issued in 1999 – this is not new! It relates to ‘Countering [tax] Avoidance in the Provision of Personal Services’ and aims to ‘level-up’ the amount of tax and NI paid by ‘off payroll employees’ – contractors – to be equivalent to on-payroll employees. It has been implemented in the Public Sector since 6 April 2017 and in the Private sector from 6 April 2021
It looks to determine which workers are ‘disguised employees’ i.e. they may not be on payroll, but they perform duties and potentially enjoy benefits that you would normally associate with being an employee. These workers are then deemed to be ‘inside of IR35’ and Income Tax and (Employers) National Insurance become payable in the same way is if they were on-payroll.
It only relates to taxation, not employment rights. This is one of the most controversial aspects of the legislation because some fear it opens the way for unscrupulous employers to push roles into an ‘off-payroll, inside IR35’ status and thus excuse them from the need to provide all of the benefits and protections employed staff enjoy, such as pension contributions, paid sick leave / holiday etc. etc. whilst allowing them to direct how the work is undertaken.
The key mechanism used in determining whether a role / worker is inside or outside of IR35 is whether the service they provide is a ‘Personal Service’ (inside of IR35) or a ‘Contracted-out Service’ (outside of IR35), determined through completing a Status Determination Statement (SDS)
How is IR35 applied?
There are many different scenarios possible. Here are just a few which relate to small consultancies and their clients:
Small Client Exclusion
The legislation provides for a Small Client Exclusion. The important word here is Client… it does not apply to the person / company providing the service, nor does it apply to an intermediary i.e. an Agency. It only applies where either
- The end client meets the criteria, or
- The SDS has determined that this is a contracted-out service, and hence the company providing the service i.e. a small consultancy could apply the exclusion as it has become the client of the worker
This exclusion may become to be seen as a loophole by HMRC and hence its quite possible, even probably, that the loophole will be closed if the market responds to exploit it i.e. lots of small consultancies rapidly become bigger consultancies! The exclusion applies if any 2 of the 3 tests applies:
- Test 1 company turnover <= £10.2m p.a
- Test 2 company balance sheet <= £5m
- Test 3 company has <=50 employees
The determination as to whether a job is inside or outside IR35 is made through a Status Determination Statement (SDS). We’ve seen how the responsibility for completing the SDS moves depending on the scenario. Those organisations that have issued blanket ‘no contractor’ decrees are largely doing this because they don’t want the overhead of (correctly) completing the SDS, as well as the potential for PAYE and NICs. It’s imperative to complete the SDS in an accurate and honest manner.
Any HMRC investigation will look at actual working practices and if these differ from the SDS, there is a possibility that whoever has completed it will not just be liable for PAYE / NICs but could potentially be prosecuted for Facilitation of Tax Avoidance under the Criminal Finances Act. The SDS should be completed and agreed between all parties, and all parties should keep a record of it. There is only a requirement for an SDS if a ‘non-employed’ party is delivering the work.
The HMRC CEST tool can be used to determine status.
Status is determined by a combination of factors. The three primary ones being:
- Personal Service – can the service only be provided by a specific individual? Were they interviewed and selected by the client? Can the client refuse a substitute? Is the worker a ‘Role Holder’?
- Mutuality of Obligation – does the individual expect to receive future work from the client, and does the client expect the individual to be available?
- Control – What, Where When How…Can the client control how the work is undertaken? Can the client stipulate location and working hours?
Less important but still contributory factors include:
- Financial Risk – does the worker get paid if the work is not of adequate quality?
- Provision of Equipment – does the client provide the tools required?
- Basis of Payment – is the worker paid a standing amount or for work done?
- Length of Contract – longer contracts can indicate MOO
- Right of Termination – Is there a lengthy (over 30 day) termination period?
- Integration & Benefits – does the worker enjoy employee benefits or hold managerial responsibilities?
- Non-exclusivity – Is the worker free to work for other clients?
- Intention of the Parties – does the contract clearly set out the intent that there should be no employment relationship?
All the following statement about IR35 are false – could you spot them?
- ‘All independent contractors will be caught by IR35’: False – even HMRC estimate that only 1/3 of ‘off-payroll’ workers will be deemed to be inside IR35. However, evidence from the Public Sector suggests the that the figure is as low as 15%
- ‘My contract / Statement of Work says clearly that I’m outside IR35 so I’m safe. My Accountant says I’ll be fine’. False – it’s really important get use the contract to frame how work will actually be undertaken, and aligned with the SDS. However, working practices will overrule what the contract says. So if the contract allows substitution but the end client doesn’t accept it, it’s a Personal Service. Is the Accountant an IR35 expert?
- ‘I’m using an offshore Umbrella company so I escape having to pay UK tax’. False – good luck with that one! There are a number of Umbrellas that have set-up using all sorts of sharp practice to try and get around the legislation. Bottom line is that if net earnings after NI (but not tax) are more than 85%, its probably illegal
- ‘If I’m deemed to be inside IR35, I’ll be entitled to sick pay, holiday pay etc etc.’ False – this legislation is about raising more tax and NI – it’s nothing to do with employment rights. In the Public Sector, there have been legal challenges to this and there have been some cases settled out of court for small sums but no ruling has set any precedent regarding employment rights
What clients are doing to approach the challenge
We have seen clients taking one of 4 approaches to the issue:
- Avoid – this is what the large banks are doing. By taking a ‘no contractors’ stance they hope to avoid having to do any assessment and avoid any tax risk / cost. The clear danger is that they lose valuable talent and can’t get transformational change implemented
- Embrace – many clients will recognise what needs to be done i.e. put time and effort into the assessments and as a result keep much of their contract resource on todays terms. There may be additional cost for some critical resources
- Fudge – some clients will apply blanket or role-based assessments as a short-cut. This will come back and bite them as HMRTC look at individual circumstances
- Ignore – I fear many clients may be in this space, especially overseas clients. Whether through ignorance or a belief that this is somehow somebody else’s problem, they won’t take any action
Where they are the end client, they have obligations that they cannot avoid, specifically completing the SDS. We have written about this on our insights page outlining how the perceived pain of this legislation can be mitigated by some simple approaches.
To understand more about IR35 and talk through implications and how we can help please book a meeting with us today.