Last reviewed 17 February 2021
In this article we look at the changes due to IR35 from Spring 2021.
The IR35 rule was introduced in 2000 to equalise the tax position between employees and individuals that provide their services, usually using a company (often called a Personal Services Company — PSC). The IR35 legislation aims to ensure a person acting as a contractor pays the same tax and national insurance as an employee if they are actually an employee. Currently, most contractors are required to determine their own status as employee or contractor. From 6 April 2021 the liability to determine this employment status will usually pass to the client/employer.
This change had been due to be introduced in April 2020 but this was delayed until April 2021 due to the Covid-19 crisis. It is expected that this change will lead to a significant number of “contractors” having to pay extra tax and national insurance as it is estimated that only 10% correctly determine their employment status.
What is IR35?
Where an individual is a contractor operating through a company, the individual can pay itself dividends and reduce their income tax and national insurance liability. The IR35, off-payroll working, rules are designed to ensure that the contractor pays the same tax and national insurance as an employee. While most arrangements involve the use of a company, the IR35 rules apply to partnerships and individuals as well. The rules apply where the contractor provides their services through an intermediary, but would be classed as an employee if they had contracted directly. Thus, payments made by the client to the contractor will be subject to income tax and national insurance as if they had been paid to an employee. Until 6 April 2021 it was the contractor’s responsibility to determine the employment status and whether the IR35 rules applied. The exception was contracts with the public sector authorities (such as the NHS) where the public sector client had the responsibility of determining the employment status and tax liabilities.
It is often thought that where the contractor works for a number of clients/customers that the contractor must be in business on its own account and not subject to the IR35 rules. This is not, however, correct as the IR35 status is assessed on an assignment by assignment basis. IR35 status is determined on each assignment on its own merits.
How do you know if the IR35 rules apply?
Businesses can refer to the HMRC tool, the Check employment status for tax tool (CEST) on the GOV.UK website. While this tool is not perfect, it provides good guidance as to what HMRC are looking for to determine if a person is an employee or contractor. Furthermore, HMRC have promised to make some improvements to this tool in time for the April 2021 change.
The type of indicators that need to be considered when determining IR35 status are the usual ones in determining if a person is an employee or independent. Where the contractor has a right to substitute another person for his or her own services, this is seen as a strong indicator that the relationship is contractor and customer rather than employer and employee. Where the client has significant control and direction over the worker this will be seen as an employee and employer relationship. Conversely, where the worker has control over how the job or assignment is completed this is seen as a contractor/client relationship.
HMRC also look for what is called mutuality of obligations. That is, is there an obligation to provide work and accept work between the parties? This is an area of dispute between HMRC and many practitioners and can be difficult to determine with confidence.
Change being introduced
The change being introduced is to move the responsibility from the contractor to the client for medium and large-sector clients. Small clients will be exempt from this obligation and the contractor remains liable for determining their employment status. A medium to large business is one that has two or more features:
turnover of more than £10.2 million
balance sheet total or more than £5.1 million
50 or more employees.
What if a mistake is made?
Where a determination is made that a contractor is not caught by the IR35 rules it is essential that reasonable care is taken in the decision-making process and the decision is itself reasonable. If reasonable care is not taken any status determination statement will not be valid and the client of the contractor will be liable to pay any unpaid taxes.
In February 2021, the Government published new guidance which confirmed that companies will not have to pay penalties on any inaccuracies within the first 12 months of the new rules coming into effect, unless there is “clear evidence of deliberate non-compliance”. The aim is to help companies implement the new rules while also recognising the difficulties they may be under as a result of the coronavirus pandemic. However, “deliberate defaulters” will be named and shamed to encourage them to get their “tax affairs in order”. For this reason, the Government has urged businesses not to cut corners when introducing these new rules.
Further information can be obtained from a government publication on the GOV.UK website.