IR35, also known as the Intermediaries Legislation, was introduced in the year 2000 and was designed to collect additional tax and NI from independent professionals (referred to in this guide as ‘workers’) who HMRC believed to be working in ‘disguised employment’.
Disguised employment is where the working practices and wording of a contract are similar to that of an employee, but where the worker enjoys the tax benefits of working through an intermediary, such as a limited company, also known as a personal service company (PSC). When a worker is seen to be in disguised employment, they are deemed to be ‘inside’ or ‘caught by’ IR35.
The 2000 IR35 rules state that if your contract is inside IR35, then 95% of the fees you earn (less certain allowable expenses of employment, which include pension premiums) must be paid as salary to the worker.
For independent professionals in the Public Sector, and as of April 2021, for those working for larger end-users (referred to here as end-clients) in the Private Sector, the new ‘Off-Payroll Working’ rules apply.
The ‘Off-Payroll Working’ rules (first introduced into the Public Sector in April 2017), state that the end-client is now responsible for determining the IR35 status of the contract, rather than the worker as was the case in the 2000 legislation.
If the worker is found to be inside IR35, they must either:
Using a PSC is no longer viable under the new rules and is not recommended.
There is new Off Payroll Working legislation written for the Private Sector which is on track to be introduced in April 2021. By this date, independent professionals working in the Private Sector need to be sure whether their contracts are likely to be caught by IR35, and if they are, must weigh up their options.
If you are not required to go on the payroll of your end-client, we recommend that you switch to working via a payroll umbrella company such as Competex Pro.
The new Off Payroll Working (IR35) rules apply to workers who provide services to public sector organisations. From April 2021, they will be extended to apply to workers who provide services to large or medium-sized companies in the private sector.
Small end-client businesses in the Private Sector will be exempt from applying the Off Payroll Working rules when they come into force. A business is classed as ‘small’ if they meet two or more of the following:
Small subsidiaries of large parent companies do not count as small businesses, and non-corporates are treated slightly differently (i.e. the rules are simplified).
This criteria applies to two consecutive years; the last accounting year with a filing date ending before the beginning of the tax year, plus the accounting year before that one. Therefore, if the end-client files annual accounts to 31 December, the accounts should be considered for the years 31 December 2019 (filing date 30 September 2020) and 31 December 2018 for the tax year 2021/22.
If the end-client ceases to be small in two consecutive years, then responsibility for IR35 switches to them from the start of the tax year following the filing date for the second financial year. Using 31 December accounts again as an example, if the company ceases to be small in both 2020 and 2021, then responsibility switches to them from 2023/24 onwards.
NB Workers whose end-clients are classed as ‘small’ will still need to assess their contracts for IR35 status and if caught, will have to apply the original IR35 rules, i.e. 95% of income must be used as salary.
No. If you are working on assignment for an end-client through a payroll umbrella company (such as Competex Pro), the payroll umbrella company is your employer and your earnings are processed through the payroll.
The Off Payroll Working rules do not apply to sole traders; they only apply to those who work via an intermediary. This is because a contract which is directly between a sole trader and an end-client involves the risk that the worker could be deemed to be an employee. The end-client is responsible for determining the employment status and, if they get this wrong, they will be held responsible.
We therefore think it is unlikely that many end-clients will wish to engage with you in this way.
We recommend that if you have previously been working via a PSC and your assignment is caught by IR35, that you switch to working via a payroll umbrella company such as Competex Pro.
Competex Pro draws on Competex’s 20+ years of experience in the contractor market. Competex Pro is set up in a way that allows you to:
Unfortunately, the new Off-Payroll Working rules are designed specifically to make PSC working more complex, difficult and costly, should the worker be found to be inside IR35.
When the new rules come in in April 2021, all PSC workers who are caught by IR35 will be taxed in a different way. If the PSC worker is caught by IR35, then the ‘fee payer’ (agency or end-client) is required to deduct tax and Employee’s National Insurance on the worker’s earnings, and to pay this to HMRC together with Employer’s National Insurance, before paying the net amount to the PSC.
There are also the following issues:
As such, the new regulations make it very difficult and uneconomic to work through a PSC if your work is inside IR35. We therefore recommend working through a payroll umbrella company, such as Competex Pro.
Once the new rules are introduced, if a large or medium-sized Private Sector end-client deems a PSC worker to be inside IR35, the end-client will have a decision to make.
It could either terminate the contract and re-issue it to reflect the new status, or it could change the worker’s working arrangements in such a way that the worker would no longer be inside IR35. It is as yet unclear whether PSC workers who are currently outside IR35, will be caught by IR35 if they are on the same assignment once the rules come in.
There is a danger of blanket status determinations being made by large organisations, as we saw with HSBC in 2019. In 2017 we saw many contracts in the Public Sector defaulting to IR35 status without the proper checks being made. This was largely due to a lack of information supplied by HMRC and a flawed CEST (Check Employment Status for Tax) tool, which was then revised in November 2019.
Your daily rate will most likely need to be adjusted if you come under IR35. As a very rough guide, the indications are that you are likely to need to increase your day rate by at least 20% to receive the same net pay as non-IR35. There are a number of factors that affect the impact of your pay so for the most accurate advice, we recommend speaking to your personal tax adviser. If you simply need a basic calculation, our payroll team may also be able to assist you.
Be aware that your end-client may offer you two different rates – a lower rate for being paid through their payroll and a higher rate for being paid via a payroll umbrella company. In the one case, the client is paying Employer’s NI and other employment costs in addition to the taxable fee. In the other case these costs of employment are paid by the payroll umbrella company.
If you switch to working via a payroll umbrella company such as Competex Pro, you may be able to make pension contributions out of your employment income, which could also affect how your daily rate should be adjusted. Please speak to our payroll team for more information.
The question of whether or not a contract is deemed to be inside IR35 depends on a variety of factors, relating to both the contract itself and the working practices. There are three employment tests designed to help engaging organisations make this assessment, along with a number of additional factors that HMRC considers.
This test focuses on the level of autonomy given to the worker. HMRC considers consultants, for example, to have more autonomy when it comes to choosing the work that they do, while employees are more likely to be assigned tasks by their employer. This can however depend on the individual’s skill and expertise, as a highly skilled employee is likely to enjoy a greater degree of autonomy than a less experienced consultant.
The ‘supervision, direction and control’ (SDC) test asks the following questions of the working practices and the wording of the contract itself:
If the answer to any of these questions is “yes”, then there’s a chance that the worker might be inside IR35.
The test of substitution considers whether the engaging organisation would be prepared to accept someone else to do the work in the event of the worker being unavailable. If the engaging organisation would not be prepared to do this and would only accept the personal service of that particular worker, it would suggest that a traditional employment relationship might be in place and that the contract could therefore be inside IR35.
In the context of regular employment, mutuality of obligation (MOO) means that one party – the employer – is obliged to provide work and the other party – the employee – is obliged to accept it.
However, non-employees have no obligation to accept work and unlike employers, the companies that engage them have no obligation to provide it.
Therefore, as MOO is a feature of an employment relationship, if it is present in a contract, it suggests that the contract might be inside IR35.
When assessing the working practices and contract, there are certain factors that would indicate that MOO isn’t present and that an employment relationship, therefore, doesn’t exist. These include:
HMRC doesn’t just consider the outcome of the three employment tests when assessing a contract’s IR35 status. It looks at a wide range of factors that might indicate that the worker is “part and parcel of the organisation” and that a traditional employment relationship might, therefore, be in place. These factors include:
If I fail on one test, then my contract will be caught.
This is not true – all three tests should be applied and all factors considered.
If I word my contract in a certain way, I can be seen to be outside of IR35
The wording of the contract should always reflect the working practices. In the event of a tribunal, it will be the working practices that will take precedence over the wording of the contract.
If my engagement is long, then I will be caught
The length of the contract doesn’t affect the status, but if the working practices change over the course of the assignment to reflect more of an employment scenario, then it could end up being under IR35. There is currently no provision for statuses changing part-way through a contract in the draft legislation, so this could create complications and we are waiting for further information on this.
If an agency substitutes another worker in my absence, I am not caught
This could equally happen in an employment scenario and is not what is meant by substitution. It is the worker who must have the right to substitute, not the agency, to contribute to an outside IR35 determination.
If I have more than one end-client, I am not caught
This can be an indicator of being in business in one’s own right and can contribute to an outside IR35 determination, but the combination of the other factors would also need to reflect that the worker is not caught.
When IR35 was originally introduced, it was the worker’s responsibility to determine whether they were inside or outside IR35. However, in the new Off Payroll Working legislation, the responsibility is given to the engaging organisation to make this assessment.
Under the new rules, HMRC have confirmed there will be an exemption if the end-client has no presence in the UK. This means they must have no UK connection immediately before the beginning of the tax year. A connection would be a UK branch, subsidiary, or office. If it has any UK connection then the new rules apply, and the overseas client will be required to issue an SDS. Otherwise, the old rules will continue to apply, and the worker remains responsible for making the IR35 assessment and paying the relevant taxes.
Under the 2021 legislation, if the fee payer doesn’t deduct tax and NI from a payment that is made to a PSC, as the rules state that they should have done, the fee payer (rather than the PSC) is at risk for the tax that should have been deducted and wasn’t. This means the end-client decides the status but is effectively not liable, which is not ideal.
The end-client must however take ‘reasonable care’ (see below) to communicate the IR35 status determination statement (SDS) and reasons, to all parties in the supply chain, down to the worker, otherwise the end-client remains liable for any tax and NI not deducted. This must be communicated before the first payment is made.
The following rules also apply:
This way of dealing with liability is intended to give an incentive for all parties to comply. This is new to the 2021 rules, and was not addressed in the 2017 version of the rules. It has been stated that if this method is successful then this will be adopted in the public sector too.
If you consider that your role is not a typical IR35 role (and perhaps is currently outside of IR35), but you receive an SDS that says you are, you have a right to challenge the decision. In such cases, we recommend obtaining your own independent status check from a specialist such as Bauer & Cottrell (see ‘Where to Find Advice’).
Critics of the legislation have pointed out that HMRC is delegating their role to the business community, as there is no third party available that the worker can go to in the event of a disagreement. We will see how this plays out in practice. Further guidelines are expected to be issued at the end of February, following HMRC’s review of practices, and we hope that these will cover these issues in more depth.
If an end-client fails to declare the IR35 status of a contract and take ‘reasonable care’ to communicate this to all parties in the supply chain, and HMRC challenges this in an investigation, the end-client may face a penalty. Penalties are levied as a percentage of the additional tax that the fee payer is liable to pay and are determined by HMRC’s perception of the end-client’s intent and the degree to which they “failed to take reasonable care” to declare their IR35 status.
If it is likely you will continue to have a mixture of IR35 and non-IR35 work, then we recommend retaining your PSC to give you the continued flexibility that the company provides. You would be able to carry on choosing when to extract funds from the company, to suit your personal tax position each tax year.
If in the foreseeable future you expect to be working for large organisations who are likely to issue an IR35 status to their workers, you may wish to consider closing your company. Please be aware that if your company has reserves on closure of more than £25k you would need to apply for a voluntary liquidation of the assets so that the reserves may be taken as a capital distribution (on which lower tax is generally payable) rather than as revenue.
For further information on closures, please ask your accountant for a copy of our handout.
HMRC developed the Check Employment Status for Tax (CEST) tool to help workers and the companies who engage them to check whether a contract and the working practices fall inside or outside IR35. However, some questions were raised relating to the initial version of the tool and its exclusion of the mutuality of obligation test. An updated version of the CEST tool was released in November 2019. We cannot endorse its accuracy, however, and we always recommend that you seek an independent contract review from a trusted provider such as Croner Taxwise or Bauer and Cottrell.
IR35 is a matter of employment law and we are not authorised to give anything other than broad advice on this matter. If you need particular detailed advice, an IR35 contract review can be obtained from an employment law specialist such as Croner Taxwise or Bauer and Cottrell.
An independent contract review highlights each relevant clause within your contract and details why it is a pass or a fail for the IR35 legislation. Remember, however, that your working practices are paramount, so they will be scrutinised and individual methods of working will also be judged to be either a pass or a fail. If appropriate, guidance and suggestions will be provided as to how to make your contract and working practices more robust.
Be aware that it is now the end-client who is responsible for determining the IR35 status of a contract, and so you would only seek a contract and working practices review in the event of a disagreement or to get an idea of what to expect and help you plan accordingly.
Some PSC workers on contract with large end-clients have already received letters from HMRC, stating that they should expect to be caught by IR35. If you have received such a letter, it is important to take independent advice before responding to HMRC, as an incorrect response could invalidate your PI insurance.
Subscribers to the Competex Tax Investigation Protection Scheme with Croner Taxwise receive free support and advice about how to respond, as part of their cover. However, even if you do not subscribe to the Scheme, please contact your accountant if you have received such a letter.