IR35: Ultimate guide to UK’s new tax law for businesses & contractors
As freelancing and self-employment gain more popularity and become more common, amending taxation laws to regulate working conditions of freelancers have become increasingly necessary. There have been changes to taxation laws in some countries, and the UK is among those. Read on to find out more about IR35, the UK’s latest rules regarding taxes for the self-employed, and organizations & clients working with them.
What is IR35?
IR35, stands for “Inland Revenue 35” which was a press release by HMRC (named Inland Revenue at the time) announcing the Intermediaries Legislation in 2000. IR35 is commonly used to refer to a certain set of rules regarding off-payroll employment. According to IR35, all contractors (self-employed professionals) and intermediaries who provide a service to clients must pay the same amount of Income Tax and National Insurance contributions as “employees”.
The IR35 rules were put in place by the HMRC (stands for Her Majesty’s Revenue and Customs) in order to prevent misclassification of employees and get ahead of tax and National Insurance contribution evasion done by “disguised employees”, contractors who must have been on-payroll employees.. The problem here is that when an employee is misclassified as a contractor, both them and clients are allowed to pay less tax and National Insurance contributions. With the IR35 rule, the government aims to prevent the use of unfair tax advantages by employees and increase national tax revenue.
How does HMRC define self-employment?
HMRC doesn’t have a clear, set definition of self-employment when it comes to IR35. However, when it comes to IR35, all we need to really know is who is liable to the rules. The concept is simple: If the working conditions (set in a work contract or service agreement–written, verbal, or implied) of a contractor resemble those of a full-time employee, they are considered to be “inside IR35”.
What makes a contractor different from an employee?
We can offer some considerations that might be helpful:
- Benefits: Full-time employees can receive benefits like paid time off, pension contributions, skill trainings, etc. alongside their wage. However, a contractor normally doesn’t receive such benefits from a client.
- Equipment: Contractors usually work with equipment they themselves financed; like computers, mobile phones or software. Employees on the other hand are provided these tools by their employers.
- Termination of contract: When an employee wants to terminate their contract, they have to abide by the rules regarding a notice period in their work contract. Contractors’ work contracts, however, can be terminated by clients at any time if no other term is specified.
What are the recent changes to IR35?
When IR35 was first announced by HMRC in 2000, it only addressed disguised employment in the public sector. In April 2017, the rules went through a reform, and by October 2017 there were hints at the private sector being included in the coming years. Which was true, as reforms including the private sector started being implemented in April 2021.
The newest reform to IR35 means that now, private sector companies and clients have a responsibility to assess whether the contractors they are working with off-payroll are subject to the IR35. This responsibility was only on the contractors before. Now, if end-users (companies or clients working with contractors) find their contractors to be “deemed employees”, they have to pay the appropriate taxes along with National Insurance and Social Care contributions. This includes intermediaries like agencies, however small businesses are exempt from IR35 rules.
Who do the IR35 rules apply to?
The off-payroll working rules of IR35 applies to all contractors that provide services to clients through their own limited company or through an intermediary. The key criteria here is classification: If a contractor could be classified as a full-time employee in case that they were to provide their services directly, this makes them a “deemed employee”.
The IR35 also applies to clients under the same circumstances. End-users soliciting services from a contractor through an intermediary or the contractor’s own limited company, are also liable to IR35 rules. Intermediaries are also required to assess the contractors providing services to clients through the company on whether they are “deemed employees”.
A contractor’s own limited company can count as an intermediary, but intermediaries can also be partnerships, recruitment agencies, or other agencies that provide services from independent workers.
The IR35 rules are applied on a contract-by-contract basis. Which means that a contractor can be a “deemed employee” under some of their work contracts, while falling “outside IR35” according to their other contracts.
Who is exempt from IR35?
Small businesses are exempt from IR35. The Companies Act of 2006 defines small businesses according to the following criteria:
- Businesses with an annual turnover of less than £10.2 million
- Businesses with a balance sheet total less than £5.1 million
- Businesses with less than 50 employees
IR35 rules also don’t apply to individuals that are completely self-employed, some that own and manage their company or those working in the public sector. However, as IR35 rules and compliance are evaluated on a case-by-case basis, it will depend on the particulars of the work and the service agreement.
What is the implication of being governed by IR35 legislation?
While making sense of the IR35 rules, we see two terms keep popping up: “inside IR35” and “outside IR35”. But what do these mean?
What does inside IR35 mean?
A contractor that is inside IR35 is someone who could be classified as an employee if they were to be contracted by the end-user (client) directly. The contractors that are inside IR35, therefore “deemed employees” are now considered employees of the client when it comes to tax regulations.
Contractors that are inside IR35;
- Work through their own companies or intermediaries but receive benefits such as paid time off, pension contributions, etc.
- Are paid per hour/day and work from the client’s premises and/or use equipment provided by them
- Are obligated to complete the work without a substitute
When it comes to working with contractors inside IR35, the client is responsible for compensating fees of rejected works or revisions due to errors.
What does outside IR35 mean?
The contractors outside IR35 can be determined by similar, but opposite factors. Contractors outside IR35;
- Are paid on a fixed rate and on a per project basis
- Use their own equipment to work and conduct work on their own premises or public places
- Can work with several different clients at the same time, on short-term projects
- Undertake all costs regarding rejected works or revisions
- Can offer a substitute in order for the contracted project to be completed
Contractors outside IR35 are responsible for paying their own taxes and NICs.
How to determine if you fall under IR35 as a contractor
As the parametrics regarding these rules are evaluated on a case-by-case basis, it can be confusing to figure out who falls under IR35. However, we have three basic points that can help when evaluating the IR35 status of contractors.
Right of Substitution
The right of substitution is when a contractor has the right to offer a substitute or hire someone else for the completion of the project agreed upon in the contract. On the other hand, if a client or a company assigns a particular role to a contractor directly, that would put that contractor inside IR35 as the contractor now could be considered an employee.
Mutuality of obligation
Mutuality of obligation is a term used to describe the status and continuation of contracts between individuals and clients. If the agreement between a contractor and an end-user is set up to be continuously renewed, or the end-user can make another contract and the contractor is obliged to accept the new one, this would be considered as inside IR35.
Right of Control
Whether a contractor falls inside or outside IR35 can also be determined by evaluating the rights of control in a work contract. If the contractor has complete control over the details of how the project will be delivered, they would fall outside IR35. These details can include when and how a project is worked on. If the client has the right of control in a work agreement, this makes this contractor fall inside IR35.
Impact of IR35 on Businesses
With the new reforms to IR35 rules, now all parties in an off-payroll working relationship have the responsibility to evaluate and use reasonable care when determining the IR35 of a contract.
Status Determination Statements (SDS)
To comply with IR35, end-clients (individuals or companies working with contractors through an intermediary) are now obliged to produce a Status Determination Statement (SDS) for contractors they work with. Intermediaries, as well, have to produce SDSs for every contractor working through their organization.
A Status Determination Statement is a document of evaluation that states the determined IR35 status of a contract, along with all information that led to the final determination. This Statement, when produced by the end-client is given to the intermediary, then passed on to the Personal Service Company or limited company, reaching the contractor at the end. In case of any changes to the work contract in question, a new SDS must be produced.
In order to ensure compliance with IR35, HMRC has decided to also implement deterring penalty fees. As HMRC can investigate up to 6 previous tax years, contractors and businesses who are found to be non-compliant will have to pay back missed taxes and penalties that differ according to the situation.
The penalties for lack of reasonable care in determining the IR35 status will be;
- 0 to 30% of the owed tax amount if the contractor/business is found to be careless,
- 20 to 70% of the owed tax amount if the error in the IR35 status is found to be deliberate,
- 30 to 70% of the owed tax amount if the error in the IR35 status is found to be deliberate and knowingly concealed.
These penalties can, again, be different according to the nature and admission of error.
Challenges faced by businesses with regards to IR35
Changes to tax regulations have the tendency to put businesses in a tough spot. Depending on the scope and nature of the change, businesses might need to re-evaluate their working systems, contracts and/or tax rates. Here are some of the challenges businesses might find themselves facing after new reforms in IR35 rules:
- Determining the IR35 status of contracts: IR35 rules can sometimes seem vague when applied to real life. This can leave employers confused about employee classifications. We recommend contacting legal professionals to ensure complete compliance.
- Increased costs: New IR35 rules means that businesses and clients working with contractors now have to pay more taxes and NICs, depending on the contract.
- Administrative burden: Businesses must keep detailed records of all working relationships with contractors in order to provide complete Status Determination Statements.
- Penalties for non-compliance: HMRC has the right to investigate IR35 statuses of contracts going back to six years, and entities inside IR35 will have to pay back-taxes in case of prior misclassification of employees. These will also include penalty fees, which can add to the already existing costs.
- Finding compliant contractors: As it is to businesses, these new changes can be hard to comprehend for contractors as well, who usually don’t have legal departments they can consult. This can make it harder for businesses to find compliant contractors.
How businesses can be compliant with IR35 regulations
In order for businesses, clients and intermediaries to remain compliant with IR35 rules, they might need to re-evaluate parts of their businesses, and make sure they classify their employees and contractors properly. Here are some suggestions for businesses/clients on how to stay compliant with IR35 if they are working with contractors:
- Keep detailed records to make sure there is no missing information when determining the IR35 status of a work contract
- Integrate a strong compliance system that calls for regular assessments and reviews of contractors
- Make sure they are working with compliant contractors through background checks
- Consult with tax and legal professionals to make sure the business and work contracts are completely compliant with IR35
Impact of IR35 on Contractors
This change to IR35 rules means that contractors are not left alone in deciding the IR35 status of their contracts. However, they still have responsibilities. For example, when SDS documents are produced and given to the authorities, HMRC can investigate the contract by asking contractors different questions regarding the working relationship; which will then have to be verified by the end-user.
For contractors in the UK, having a “deemed employee” status is only in regards to taxation regulations. If a contractor is found to be inside IR35, their employment status still stays the same; they won’t have any rights of demanding benefits from their clients. Also, when it comes to small businesses, contractors have the responsibility of determining their IR35 status by themselves.
Diligence is key
These reforms can make working as a contractor and working with contractors a little more complicated in the UK. The best way to stay compliant is to be diligent. If you have a business that might be inside IR35, collect and archive records properly and consult with legal professionals to make sure you are legally compliant in your working conditions.
Keep watching Ruul Blog to stay informed on the latest developments in laws and regulations surrounding on and off-payroll working relationships.
Are the IR35 reforms scheduled to be withdrawn in April 2023?
In September 2022, Chancellor Kwasi Kwarteng announced that the IR35 reforms would be repealed in April 2023. However, this repeal has since been canceled.
What is the CEST (Check Employment Status for Tax)?
The Check Employment Status for Tax is a tool on the UK government’s website, where individuals can provide information and check the classification of an employee or a contractor.
Does a contractor inside IR35 become a full employee?
No. Even if a contractor is legally inside IR35, that is only for tax purposes.
Does IR35 affect sole traders?
Sole traders are not affected by IR35. However, rules regarding employee classification are still valid for sole traders working with clients.
How do I check my IR35 status?
You can use the CEST (Check Employment Status for Tax) tool to check your IR35 status.
Can a contractor appeal an IR35 determination?
Yes, contractors can appeal a IR35 determination if they believe their contract is outside IR35. For this, the contractor needs to reach the end-client and ask their reasons for the determination. Contractors can also provide their own documents and reasons for the change in status. The end-client is given 45 days for a response.
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