This article is updated as of 27 March 2020 for accuracy and correctness. We will continue to update this article as new developments unfold.
In light of recent events surrounding the coronavirus and challenges faced by businesses nationwide the proposed changes to IR35 will be delayed until 6 April 2021.
Companies and individuals affected will have an additional year to prepare. This comes as part of the package of measures aimed to ease the pressure on companies due to COVID-19.
Until then, for the private sector, the current IR35 rules will continue to apply which means it remains the individuals’ personal service companies responsibility to assess if they are within IR35. For the public sector, it remains the client’s responsibility.
As of 6 April, 2021 important changes are coming to IR35 (off-payroll working). If you are a contractor or a freelancer currently providing your services through an intermediary such as a Personal Service Company (PSC) you set up as a limited company, you may be affected.
In this article we’ll cover the IR35 changes to come and how you can get your contracting business ready going forward.
What is IR35
IR35 is a tax legislation that was introduced in April 2000 to combat tax avoidance. Its purpose is to make sure that contractors using an intermediary to provide their services are not in fact disguising employment to avoid paying the correct tax.
It ensures that workers, who would have been an employee if they were providing their services directly to the client, pay broadly the same income tax and National Insurance contributions (NICs) as employees.
Prior to 2017 contractors operating through a Private Service Company were responsible for determining if the assignment was inside the IR35 rules and pay the according employment tax.
In 2017 that changed for the public sector which now meant that government and local authorities would be responsible for assessing employment status and pay taxes due instead of contractors.
What are the IR35 changes in April 2021
Starting April 6th 2021 private sector companies will be responsible to determine the employment status of a contractor’s assignment and deduct any employment taxes due and remit taxes owed to HMRC.
This means as a contractor, it will now be your clients who decide if a contract falls inside or outside IR35 rules and if PAYE tax and NIC needs to be deducted.
The private sector also includes third-sector organisations, so if you’re working for a charity this may affect you and your client.
At that point, your client will be responsible to issue your PSC or employment agency a written “Status Determination Statement” which determines the IR35 status of the contract.
In addition, the 5% administration allowance will be removed from contracts that are within IR35 because the burden of responsibility now falls with the client and not the PSC.
These new regulations are introduced to increase compliance and are an extension to the 2017 rules that apply to the public sector. They don’t introduce a new tax liability.
Government reported non-compliance is widespread and estimates that only 10% of PSCs that should be applying are actually doing so. This change aims to address that and is forecast to net the Treasury an additional £1.3 billion a year by 2023-24.
Private sector medium and large businesses
For companies with more than 60 employees it is the responsibility of the employer to decide whether you are within the rules.
Unfortunately, before the rules being postponed a lot of the large corporates were just taking blanket decisions and were not prepared to go through the available procedures. We hope given the additional year to prepare this will not be the case anymore.
Come next year, you could find yourself in the invidious position of being taxed as an employee with none of the benefits whatsoever.
No doubt the large corporates may use this as an opportunity to drive rates down. Banks and insurance companies will benefit greatly because they will no longer have to pay the VAT on the services supplied to them by the contractors, which they can’t recover.
In this sector of the economy the VAT loss to the Treasury will be greater than the employer’s national insurance received. Banks in particular benefit most and will be laughing all the way to the, err……..bank. Well done HMRC!
IR35 exemption for small business
There’s an exemption If your clients meet the definition of “small” as defined by the Companies Act of 2006.
To qualify as a small business your client must meet two or more of the following criteria:
- Annual turnover less than 10.2M GBP
- Balance sheet less than 5.1M GBP
- Less than 60 employees
If they qualify as small they won’t be affected by the off working payroll changes and the responsibility of determining the IR35 status of an assignment will remain with the contractor. In this case the 5% administration allowance is allowed.
That’s certainly a relief for any freelancer working with a small company. However, this exemption does not apply to the public sector even if the entity is considered small.
Do IR35 changes apply to sole traders?
The answer is simple, IR35 does not apply to sole traders. If you run your business as an individual without a company structure you won’t be affected by the coming new IR35 rules.
That’s because you’re already responsible for paying Class 2 and Class 4 National Insurance on your taxable profits and reporting it on your self-assessment.
A recent Treasury Review confirmed that the new rules would not apply if an organisation is entirely overseas and has no UK presence. In that case current rules will continue to apply and the contractor’s limited company/PSC will be responsible to determine the status of the contract.
What affects your IR35 status
Although your client is responsible to determine your status, HMRC can look beyond your contract and more into your actual working practices.
There are 3 keys IR35 tests used by HMRC to establish if your assignment is within IR35 or not. So, it’s important that you work with your client to make sure your contract is aligned with your daily practice.
In addition, drafting an IR35 friendly contract and making sure you have all the correct clauses is a complicated process so you should always take advice first. A recent case that went through the courts has shown that the wording in your contract is very important.
The principle of control considers the extent a client controls how, when, where and what work is carried out. Are you able to dictate how you will undertake the assignment, set your own schedule and mutually agree on the deliverables?
2. Personal Service and Substitution
The principle of personal service and substitution looks at your right to send in a substitute to perform the work or if you are required to do it yourself. Do you provide your personal services exclusively to a client or does your business provide its services? Your contract should always include a substitute clause.
3. Mutuality of Obligation
This principle of mutuality of obligation looks at whether the client is required to provide consistent paid work and if you are obliged to accept this work. To be considered a contractor it should be clear that the client hires you to perform a specific task and there are no expectations of further work. Once the contract is fulfilled you may create a new contract for another project or deliverable.
4. Other Factors
There are other factors beyond the ones listed above and the list constantly changes based on new cases examined by HMRC. We suggest you check with us or seek professional help when in doubt.
Check employment status for tax (CEST)
HMRC have an online tool, called CEST, that you can use to assess whether you will be classed as an employee or self-employed for tax purposes.
They have stated that they will stand by the determination if you answer accurately and without trying to get particular outcome.
However, you would be well advised to avoid.
It does not accord with the current law, as laid down by the courts and ignores completely mutuality of obligation. It also requires that you ignore certain equipment because you would normally have purchased that anyway.
What if I don’t agree with my IR35 designation?
The new reforms stipulate that a contractor will have 45 days to challenge their designation, and an employer will have 45 days to respond.
HMRC said: “We believe that that statutory obligation will allow contractors what they need to come to some kind of solution with their employer.”
You will need to discuss this with your client and tell him in writing why you disagree. He should then let you know if he agrees and provide you with a new status determination of why he doesn’t agree along with his reasons.
During the dispute you should keep records and the initial determination still holds valid.
IR35 changes impact for contractors
If your contract falls inside the IR35 legislation, then your client must deduct tax and National Insurance contributions from your fee just as they would with a typical employee and remit to HMRC.
The financial impact can be significant. According to Contractor Calculator, “It can reduce the worker’s net income by up to 25%, costing the typical limited company contractor thousands of pounds in additional income tax and NICs.”
So if you’re like many contractors who have decided to give up some benefits in order to work on your own terms or bring in additional income you could be negatively impacted.
IR35 changes penalties
For the first 12 months our Chancellor has told us that HMRC will adopt a light touch approach.
Customers will not have to pay penalties for inaccuracies relating to the off-payroll working rules in the first 12 months unless there is evidence of deliberate non-compliance.
Penalties will only be applied where the parties involved operated with what appears to be fraudulent intent.
However, anyone involved will still have to pay the tax, even if they make mistakes.
Roughly translated, the light touch means that the regulations have not been finalised and quite a lot of the complexities are still being considered.
Prior and current contracts
HMRC has confirmed it will not use information resulting from the change to open a compliance check for prior tax years. Any change in status will not lead HMRC to open a historic enquiry unless there is reason to suspect fraud or criminal behavior.
The rules will only apply to payments made for services provided on or after 6 April 2021. So, that means any work currently outside IR35 that you are completing for a client up to 6 April 2021 will not be subject to the changes. You should get paid in full.
That is even if you invoice and get paid after the date of the change because it’s based on when the work was actually done and not the time you invoice.
If on or after 6 April 2021 your client issues a “Status Determination Statements (SDS)” where you are considered “employed” and deemed an employee, the end-client will now have to make the necessary PAYE tax and employee NIC deductions from your fee and give it to HMRC. They will pay the employer NIC.
One of the most important aspects to keep in mind going forward is to have a good grasp of the factors affecting your status and understanding how your clients will approach IR35. Working together with them, within the law, to set the terms of engagement and working practice to respect the rules.
HMRC has stated that clients cannot apply a blanket rule across all contractors. They need to take reasonable care whether off working payroll rules apply or not.
Applying group decision may be permissible if the role, working practices and contractual terms are similar.
But, it is not right to rule all engagement inside or outside without careful consideration of the contractual agreements and working arrangements.
If you take the time to fully understand the legislation and get guidance early there is nothing to fear from the coming changes. Keep good records and document all communication so you’re prepared and have a good defence in case of an HMRC investigation.
In addition, it’s also good to fully distinguish yourself from your business. It should be clear from your marketing material a client is employing your company and not you personally to perform the work.
How we help contractors
If you’re still struggling to understand IR35 we can help. As Chartered Accountants in London, BrooksCity has over a decade of experience helping contractors with their accounting needs.
We have a full range of solutions to make sure you stay compliant whether you’re working inside or outside IR35. To get started request a quote here and we’ll be in touch shortly.