What is IR35?
What is IR35?
IR35 legislation was first introduced back in 2000 and was designed to tackle tax avoidance by those who created artificial limited companies to pose as a contractor as opposed to an employee for a business. Since 2000 the legislation has undergone several amendments with one of the most recent being implemented in 2017 that applied to those working in the public sector only and placed the responsibility of determining the worker’s status on the hiring company. This rule is now being applied to the private sector and came into force the 6 of April 2020.
According to HMRC’s report, 130,000 contractors were affected by IR35 reform in both the private and public sectors from October 2019 to March 2022, but it is important to know first what IR35 is and how you can be affected.
What is IR35?
IR35 is a tax law that attempts to stop people from evading taxes by offering their services to customers through an intermediary, like a limited company. These people, who essentially appear, act, and behave like workers, are also referred to as “disguised employees” by HMRC. But because they are listed as limited businesses, they pay less tax than those who are employed.
A business can save a lot of money by hiring people as “contractors,” as they won’t have to cover job benefits like paid time off for vacations, sick days or pay employer National Insurance Contributions (NICs). Both businesses and freelancers benefit from this scenario.
How may it affect you?
Since the introduction of the new rule to private sectors in 2020, now not only affects contractors and freelancers, but also employers and companies who use them. The company hiring external workers will become responsible for determining whether or not NIC and income tax should be deducted from the contractor’s pay. Similarly, if you are a recruitment agent who places contractors, you will become responsible for declaring the contractor’s status if you handle their pay.
Small businesses will be exempt from the new rule (however our advice is that you should still make yourself aware of the rules should the government extend the legislation in the future to all sized businesses). A ‘small business’ is defined by the Companies Act 2006 and states that you should meet two or more of the following criteria in order to qualify:
- A maximum of 50 employees
- Annual turnover under £10.2 million
- Balance sheet which is no more than £5.1 million
What impact will it have if you are a contractor?
If you are a contractor that is hired by a qualifying small business then be aware that the responsibility falls on you to prove your status as a legitimate off-payroll worker (non-employee) and are not required to have NI and income tax deducted from your pay.
The effects of IR35 on the economy are substantial. As a limited company contractor you will pay thousands of pounds more in income tax and NICs as a result, which can lower your net revenue by up to 25%. As a result, you could end up owing thousands of pounds.
What is your status as a contractor?
IR35 currently only affects those who provide services to public sector organisations. If you provide services for the private sector, you should still be cautious of falling into the scope of IR35 as the government have plans to roll this out into the private sector come 2020.
There is no definitive way to avoid an investigation from HMRC in any circumstance which is why Tax Fee Protection is recommended. Nevertheless, the best way to determine employment status is by applying three key principles:
- Control – As someone who is genuinely self-employed providing services, you should be able to demonstrate a significant level of control over your own work. This can include choosing your own hours as to when to complete the work by a deadline date or schedule, where you work such as at home as opposed to having to be at the employer’s office, and also the level of autonomy you have over performing your job as opposed to being instructed on how you should be working.
- Substitution – In your absence, could a substitute perform your duties? For example, if a plumber was contracted to service an office but was off sick, they would be able to send someone else to fix a reported problem. Understandably, many self-employed people do not have employees, but this does not mean they fail this test. Ultimately, you will need to be able to show that the employer is free and easily able to replace you with an alternative.
- Mutuality of Obligation – This refers to the offer of work. Should HMRC spot that the employer is obliged to provide continuous work for you, and you in return are obliged to complete it, then it is likely you fall into IR35. Contractors often work on a project-basis so once that work is complete, there is no guarantee that more work will be offered by the same employer. On the other side, should the employer offer additional work, contractors should be able to freely decline that work if they need to.
Other forms of proof
Although the three rules above are the key tests for employment, HMRC will look to gather more supporting evidence should they decide to investigate. The same evidence could be used to your defence should you be unable to satisfy all of the above assessment factors.
- Equipment – Do you own and use your own equipment to complete the task? For example, if you are a graphic designer, do you have your own computer and software to fulfil a brief, or do you use the facilities of the employer?
- Risk – As a self-employed person, do you carry all the risk of running your own business? This is often seen in the scenario as a mistake. Would you be personally responsible for rectifying it at your own cost or would the employer take responsibility on your behalf such as where an employee makes a mistake?
- Payment – Employees are often paid a salary at regular intervals such as weekly or monthly, whereas contractors are paid per project. Can you show that you take payment at project milestones or only once a job is complete?
- Exclusivity – Do you have other clients? Or are you able to show that you have the freedom to take on other clients?
- ‘Part and parcel’ to the organisation – Are you integral to the organisation? Where you and your services become engrained into a company, so much so that they are heavily reliant on you, then it may be the case that you are treated more as an employee than as a contractor. An example of this is where you manage a team where other employees would report into you.
How IR35 impacts private sectors
To implement these new rules there are two processes which have been introduced:
- The hiring company (sometimes also referred to as ‘end-client’) will be required to confirm the IR35 status of the worker and provide a ‘status determination statement’ which includes a declaration of status and provides adequate reasons for reaching this conclusion. Until this is done, the end-client remains responsible for collecting NIC and income tax.
- If you are a contractor and do not agree with the decision made by the hiring company then you are able to request a review. The end-client must complete this within 45 days and respond to you with their reasoning behind the decision.
How to calculate the deemed payment if IR35 applies?
In the event that IR35 applies to you HMRC have provided an 8 step guide for you to calculate your deemed employment payment manually.
However, it is crucial to understand what the IR35 deemed payment is first. IR35 deemed payment is when you are compliant with the law, you make this contribution to HMRC to cover the extra tax and national insurance that are owed on an assignment where the IR35 regulations are in effect.
These are the steps you will need to follow:
Step 1 – Deduct 5% of your off-payroll income
Add up all payouts (using sums excluding VAT) and other benefits that the company got for all IR35 contracts that year. Apply a flat rate expenditure allowance of 5% of this revenue as overheads, which is a deduction intended to cover the extra expenses associated with working through a service business.
Step 2 – Add payment make directly to the worker.
Include any payments or benefits that the customer made directly to the employee rather than the middleman and that would have qualified as employment revenue if the employee had been employed directly.
Step 3 – Deduct expenses
Deduct costs that the intermediary spent for the activities during the tax year. The costs must have been mainly done for the performance of the responsibilities in the employment contract.
Each contract will be treated as a different permanent employment for the purposes of travel expenses if the off-payroll regulations are in effect. If you frequently travel from your house to a place of employment for an off-payroll job, you cannot claim travel expenses.
Step 4 – Deduct capital allowances
You will deduct any equipment that was bought to complete the duties specified in the contract. In case of buying the equipment an machinery outside the contract and from own initiative, will not be eligible for a deduction.
Step 5 – Deduct pension contributions
Subtract the employer’s payments to a recognised pension plan.
Step 6 – Deduct employer NIC (National Insurance Contributions)
Regarding the employee’s benefits and salary, deduct any Class 1 and Class 1a NICs that the intermediary paid to HMRC during the tax year.
Step 7 – Deduct any benefits and salary already paid
Subtract the sum of the employee’s wages and benefits that were paid by the service supplier and were treated as employment revenue.
Step 8 – Deduct NIC on the deemed payment
After completing all the steps, you must pay tax and NIC on the deemed payment.
The company must include the presumed job payment on or before April 5 in order to comply with the requirement to pay PAYE and NICs owed.
As you can see, whether you work in the public or private sector, IR35 aims to stop people from evading taxes by providing their services through an intermediary, like a limited company. It can be difficult to determine whether IR35 applies to you or not; if you still have concerns about how IR35 operates and how you will be taxed, check out our self-assessment tax return services or get in touch with one of our accountants who can help.
Stay up to date
Looking for some help?
You can find out more about our payroll service.