For those of you who have heard about IR35 regulations….you have my sympathy! It is an issue that affects many people who are contractors or run small businesses and intricate details involved can create much stress to those who are unsure where they stand.
What is IR35?
The IR35 rules were introduced in 2000 to combat “disguised employment”. This is just typical tax jargon (of which there are many!)
In layman’s terms it is where organisations engaged individuals through an intermediary such as their Limited Company, instead of engaging the individual directly.
For example, Organisation XYZ would look to engage the services of John Smith Limited, a company owned 100% and managed by Mr Smith, instead of Mr Smith himself. Mr Smith would go out and work for Organization XYZ and Organisation XYZ would invoice Mr Smith Limited for his services.
If you operate through an intermediary (e.g. your own limited company) then you can withdraw profits from the company at a time that suits you by way of a salary to use up tax allowances and dividends.
Dividends do not attract national insurance and also benefit form an additional tax allowance. As well as this, any amount over the tax allowance is taxed at a lower rate than if the money was paid out as a salary.
So the worker can receive more pay, after tax, than if he or she were an employee operating under PAYE….Happy days I hear you say!
Sadly the government however weren’t as happy with this!
In a time where they needed as much revenue in their own coffers to plug their ever growing financial black hole, they couldn’t have people trying to mitigate their tax liabilities as they needed to repay the vast amount of debt (and interest) in which various governments have saddled the UK taxpayer with ….but that’s another story!…..and another blog I expect in the coming months!
The result of this was the government introducing IR35 legislation.
The IR35 rules allowed HMRC to “look through” the intermediary and, in cases of “disguised employment”, require the intermediary operate PAYE and NIC and tax the worker as if they were a normal employee. Thus, eliminating any tax efficiency from operating and invoicing through a Limited company.
In particular, HMRC’s concern was that some employees were resigning from their jobs one week only to be engaged the next week as a freelancer or contractor doing the same job but with less tax and NICs being paid to HMRC.
IR35 rules seek to identify those who would be, in HMRC’s opinion, classed as an employee if they were not providing their services via an intermediary and tax them accordingly.
What do HMRC look for when assessing IR35
This is the crux of the issue and the question on the lips of everyone who may be worried about IR35.
In typical HMRC style the legislation is very “wishy washy” and subjective and open for interpretation. Tax is sometimes taxing, despite what they might have you believe!
Determining someone’s employment status for IR35 purposes can be very challenging in some cases.
HMRC will not only look at the contract when making their decision but the business working practices.
HMRC will consider the following factors:
- Control: what degree of control do you have over how, when and where the services are provided. The less control you have, the more you are leaning towards being employed.
- Substitution: if you are unable to provide the services yourself, can you send a substitute and are there any restrictions by the client or agency. If you cant substitute yourself for another worker then again you are heading towards employment.
- Mutuality of obligation: mutuality of obligation is a concept where the employer is obliged to offer work and you are obligated to accept it. This can be during or after the contract. If this rings true then again you are leaning towards employment in the eyes of HMRC.
There are additional factors that can support the principal tests, such as:
- Requirement to maintain adequate business insurance throughout the contract.
- A responsibility for repairing defect work at your own cost and in your own time.
- A responsibility for providing training and equipment in relation to the services provided.
If you are not responsible for these factors then you are looking at being considered an employee.
- Are you the worker entitled to sick pay, maternity pay, holiday pay or a workplace pension? If so it would be very difficult to argue that you are not employed.
HMRC will access the case based on all of the factors above. They will not consider one factor in isolation. These aren’t an exhaustive list of the factors HMRC will consider. HMRC may ask further questions depending on the circumstances and the answers to certain questions given.
Changes to IR35
From 6th April 2017 HMRC have introduced some changes to the way they assess IR35 for contracts performed in the public sector (eg NHS, Police force, BBC).
Essentially, the current IR35 test explained above remains the same. This means that if an individual is providing services through an intermediary, and the circumstances are such that if the client directly engaged the individual, the individual would have been an employee or an office-holder of the client, then IR35 applies to that engagement.
The previous position (and the remaining one for the private sector) was that the worker and their intermediary was required to decide whether IR35 applied to the engagement or not and if it did, were responsible for operating the deemed payment calculation at the end of the year (paying PAYE and NIC as if they were employed).
The new public-sector rules have in effect shifted the liability and the responsibility to comply with this legislation to the “fee-payer” (i.e. the person paying the intermediary).
It is now the fee-payer that is required to make the decision on the applicability of IR35 to the engagement. If IR35 does apply, then it is the fee-payer who is responsible for operating the deemed direct payment calculation to the payments it makes to the intermediary (i.e. deducting tax and NIC under PAYE).
According to HMRC, this latest IR35 change could yield an additional £185m during the 2017/18 tax year.
I’m sure even Phillip Hammond might raise a smile with that news!………well lets not go too far I suppose!….probably more chance of England winning the world cup in Russia this year!
What to do?
We recommend that all businesses operating in the contractor market, request an IR35 review before signing a contract with a client or agency.
If you would like any advice on your specific situation then feel free to contact us at BJT Accountants and we can assist you in the process.
As well as this HMRC has created an online tool for people who would like to check their employment status for tax at https://www.gov.uk/guidance/checkemployment-status-for-tax, It could help you find out whether IR35 rule changes are likely to apply to you. 01 May 2018 Tax update, Ltd companies.