What, where, how, why, when?

The time has now passed whereby the government rolled out the latest changes to its off-payroll tax legislation, also known as IR35. Introduced in April 2021, the reforms will be HMRC’s biggest change yet, impacting contractors working for medium-sized and large organisations across the private sector.

It will bring the private sector IR35 rules in line with the public sector, so that contractors and freelancers will no longer be responsible for determining how they should be taxed based on the work they do. Instead, the responsibility will fall to their clients, who must decide whether IR35 applies to them or not.

While this certainly doesn’t spell the end of the contracting profession – this is an industry that has survived an onslaught of legislation over the past two decades – the extension of the off-payroll rules to the private sector is, without doubt, the most fundamental change to IR35 since it was launched in 2000. Here is an overview of what you need to know.

Why is HMRC introducing the new IR35 rules?

HMRC is introducing these stricter rules to crack down on those working through a limited company purely to reduce the tax and National Insurance contributions (NICs) they pay. The problem also lies with some unscrupulous employers who choose to pay workers via intermediaries to side-step providing benefits and employment rights – such as holiday and sick pay – to people who should, in fact, be employees.

HMRC has dubbed these workers ‘disguised employees’ – those who are treated as an employee but are paid as a contractor. The taxman believes it could be missing out on some £1.2 billion a year by 2022/23 if it didn’t go ahead with these changes.

Here is the official statement from HMRC: “The [IR35] rules make sure that workers, who would [be] an employee if they were providing their services directly to the client, pay broadly the same tax and NICs as employees.”

Who will be affected by the IR35 reform?

The new IR35 rules will apply to all contractors who work through an intermediary – usually their own limited company or personal service company (PSC) – and engage with any public sector organisation or medium- to large-size private sector company. A company is classed as medium-large if any two of the following applies:

  • More than 50 employees
  • A turnover of more than £10.2 million and
  • A balance sheet total of more than £5.1 million.

Charities fall into this category too. So, if you’re a contractor or freelancer working for a medium- or large-sized charity, IR35 changes will affect you from April 2021.

If a contractor or freelancer provides services to a small private-sector client (i.e. one with fewer than 50 employees etc), the intermediary will still be responsible for determining their employment status and whether IR35 rules apply.

What happens next?

If a limited company contractor provides services to a public sector client, or a medium or large-sized private sector client, they need to get a Status Determination Statement (SDS) from their client, including the reasons behind that determination. HMRC says that the contractor will be able to dispute the determination given to them if they disagree with it.

If the contractor agrees that the off-payroll working rules apply, then the fee payer is responsible for deducting tax and NICs and paying it to HMRC. If the rules don’t apply, the contractor’s limited company remains responsible for deciding their own IR35 status and paying all relevant taxes to HMRC themselves.

How will clients decide my IR35 status?

HMRC is encouraging private and public sector organisations to refer to its guidance and use its Check Employment Status for Tax (CEST) tool, which asks a series of questions to determine whether IR35 applies or not. It’s advisable not to use this tool and to instead get an independent IR35 opinion/status determination as the tool has been widely criticised due to assumptions it erroneously makes, and its results hold no more sway in a tribunal than a third-party opinion/status determination would.

You should consider a number of factors, but in short, it all boils down to whether you would be classed as an employee if you were contracted directly with the client.

If your client provides you with the equipment you need to carry out your job (such as a laptop), dictates where you work and what hours you work, will pay you overtime if you work longer than your contracted hours, and must give their consent for you to work with other firms, it’s very likely that you land squarely inside IR35.

As well as deciding your employment status for IR35 purposes, your client must also explain how they reached their decision, plus maintain detailed records of their decisions and fees they’ve paid.

If the client decides that an assignment is ‘outside IR35’ and, therefore, that the tax rules don’t apply, they must demonstrate they took ‘reasonable care’ during the decision-making process. If they don’t, the status determination statement will be invalid, and the client will be liable for the unpaid taxes.

This clause has been a dealbreaker for many large firms, who have decided that the hefty fines they may face if they make a wrong determination are not worth the risk and instead would prefer to stop using contractors altogether. However, there are many other risks outside of IR35 that end clients should consider before making a rash blanket determination – their contractors taking their skillset and knowledge of internal company processes to a competitor, for one.

What happens if you’re deemed ‘inside IR35?’

If you’re deemed inside IR35 – i.e. that you’re operating via a limited company for tax purposes when you should be classed as an employee – it’s not the end of the world. You’re still working for yourself, it just means that your tax and NICs will be deducted from your fees and paid to HMRC. Yes, this will reduce your net income as you’ll be paying a higher tax rate similar to a full-time employee, but you can continue working as usual.

Remember, just because you’re caught by IR35 on one particular project, doesn’t mean you will be for the next. Employment status should be set on a contract-by-contact basis; it doesn’t automatically apply to all other contracts you take on.

Is an HMRC IR35 enquiry likely?

If HMRC disagrees with an IR35 determination, they could investigate at any time and insist on back payment of tax, as well as fines for late payment from the fee-payer (either your end client or recruiter usually). When carrying out their investigation, HMRC will look at what’s written in the contract as well as the actual working relationship between you and the client. That means each contract must reflect the individual circumstances of the work engagement, and why working practice assessments shouldn’t be overlooked when preparing for the reform.

Post-enquiry, HMRC will give its opinion on whether IR35 applies. If you or your client disagrees, you can object. HMRC will then issue a decision, which can be formally appealed.

Those found within IR35 following an HMRC enquiry must pay income tax and NICs due, as well as any interest due. Those who are found not to have exercised reasonable care in completing their tax and NICs returns may also have to pay a penalty.

There’s still time to get prepared for IR35

If you are a genuine contractor, freelancer or consultant who is in business on your own account, you should have nothing to fear from IR35. Don’t be tempted to join non-compliant tax avoidance schemes as an alternative to the limited company model. This could end up being a costly mistake in the long run.

You simply need to take the time to understand the legislation, apply best practices to stay compliant with the rules and have a defence strategy in place should you be investigated by HMRC.