IR35: An Ultimate Guide To UK’s Tax Laws
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IR35 has recently been the subject of much discussion, and you may have seen more information about these tax rules in the IR35 News. As part of his mini-budget, the then Chancellor Kwasi Kwarteng, proposed changes to the rules that govern off-payroll workers on 23 September 2022. In a wider U-turn on government policy, the new Chancellor, Jeremy Hunt, scrapped these plans on 17 October 2022
As of the time of writing, the off-payroll working rules that apply to contractors remain in place and unchanged. Here, we explain how the law works and whether or not you are affected by it.
What is IR35?
IR35 is a set of rules that are designed to identify contractors and businesses which are avoiding paying the appropriate tax by working as ‘disguised’ employees.
According to the IR35 Assessment, the legislation was introduced in April 2000 with the purpose of ensuring contractors pay the right amount of tax and national insurance contributions.
There are specific IR35 rules that apply to individuals who are employed but have registered as a limited company or work for a third party to create the impression that they are self-employed.
The so-called disguised employees may be hoping to save money by avoiding the tax and National Insurance Contributions that they would be required to pay if they were considered employees. Employers may also benefit, since they will be able to avoid paying employers’ NICs and provide employee benefits, such as holiday pay and sick leave.
The Off-Payroll Working Rules: Who Qualifies For IR35?
Off-payroll working rules are applicable to contractors who use intermediary services but who would still be considered employees if they provided their services directly to the company. In this case, the intermediary could be a private limited company, a personal service company (PSC), a partnership, or an individual.
You may be subject to IR35 rules if you are:
- An employer who receives services from an intermediary.
- A worker who provides services via an intermediary.
- An intermediary who provides services on behalf of another person.
Let’s suppose any of the conditions explain your employment status. If this is the case, you will be subject to income tax and National Insurance Contributions, which will be deducted from your earnings and paid to the HMRC.
In addition, the government has announced that the off-payroll working rules will not apply to the 1.5 million small businesses. If an employee falls under IR35 in the private sector, it is the employer’s responsibility to determine whether or not he or she is subject to it.
IR35 Exemptions: Who Is Eligible?
IR35 rules do not apply to small businesses. In order to qualify as a small business, it must meet at least two of the following criteria:
- The annual turnover should not exceed £10.2 million
- The balance sheet should not exceed £5.1 million
- The number of employees should not exceed 50
Inside IR35: What Does It Mean?
“Inside IR35” means that you are classified as an employee for IR35 Tax Law purposes and subject to Pay As You Earn (PAYE).
If a contractor falls within IR35, he or she must pay the same amount of income tax and National Insurance Contributions as a permanent employee.
Employers who hire contractors within IR35 must also pay matching National Insurance Contributions to the government.
Outside IR35: What Does It Mean?
The term ‘outside IR35’ means that you are not considered an employee of the client who uses your services.
A contractor who operates outside IR35 is responsible for ensuring that he or she pays the proper amount of tax outside of PAYE.
How IR35 Works – The Tests Of Employment
Since The IR35 Case Law essentially turns a legitimate one-person small business into an employee, it is underpinned by employment laws and case law. Therefore, the UK legal system applies the employment tests developed over decades. IR35 case law dates back to 1968 in Ready Mixed Concrete (South East) Ltd v Minister of Pensions, a seminal employment law case. Recent cases, especially those ruled on since IR35 was introduced, may also apply.
In essence, an HMRC inspector will attempt to disregard the written contract between the worker and their client, relying on the actual nature of the working relationship to create a ‘notional contract’. The inspector or tribunal judge will use the notional/hypothetical contract to determine whether the contract is an employment contract, when IR35 applies, or one for business-to-business services, where IR35 does not apply.
It is not surprising that interpreting these tests requires expert knowledge of employment law. In addition, it is not possible for independent professionals to become experts in decades of employment status case law, nor can HMRC’s tax inspectors, nor can hiring clients.
Determining whether you are caught by IR35 is complex, and ideally, you should seek expert IR35 advice.
The Control, Substitution, and Mutuality of Obligations
From the Ready Mixed Concrete case, IR35 determines employment status by applying three principles.
The following are the principal ‘Tests of Employment’:
- Control: What degree of control does the client have over what, how, when and where the worker completes the work
- Substitution: is personal service by the worker required, or can the worker send a substitute in their place?
- Mutuality of obligation: mutuality of obligation is a concept where the employer is obliged to offer work, and the worker is obligated to accept it.
Additionally, other factors that determine whether you are caught by IR35 include the nature of the contract, whether you take a financial risk, if you are an employee of the engager, and whether you are in business on your own account.
In light of all of this evidence, IR35 applies if the balance of probabilities indicates that the worker is an employee. A worker, for example, who is genuinely entitled to send a substitute in their place will not be required to provide personal service, so IR35 will not be applicable. Nevertheless, relying solely on that can be dangerous.
How Do You Avoid Being Subject To IR35?
There are some general factors that can play a significant role in keeping someone out of IR35. The following are some common factors:
- Equipment and work location – The organization is generally responsible for providing workers with a workstation and all necessary equipment when they work for them. Consequently, if someone uses their device to work from home, they are likely outside IR35.
- Employee benefits – Contract employees without the ability to contribute to a pension plan, receive sick pay, receive maternity leave, and receive holiday allowances are also excluded from the legislation.
- Risk factor – Someone who uses their own devices to complete a client’s project while bearing the costs of running the equipment is considered self-employed and may benefit from IR35 tax relief.
In general, self-employed workers are paid one-off sums for the complete service package that they provide rather than a fixed salary for ongoing work, which can keep them outside of IR35. It is therefore likely that a contractor will be considered outside of IR35 when he or she works for a firm using personal equipment, from home, and is paid a fixed compensation.
Public and medium-sized businesses within the private sector are now subject to IR35 rules as of the 6th April 2021. All employees, whether they are employed directly or via an intermediary, need to be determined by the companies for the proper tax deduction.
Your employer determines your employment status when you work as a contract employee for a client, but your intermediary is responsible for determining your employment status.
Whenever a contract worker provides services to a client, medium- and large-sized companies will determine whether the employee will provide services as a self-employed individual or as an employee. If the employer is a small organization, the employment status of the worker will be decided by the intermediary.
When To Start Applying The Rules Of IR35?
Client’s responsibility in the private sector –
Find yourself falling under the conditions listed above and eligible for implementing the off-payroll working rule. As of 6th April 2021, you should begin applying the new rules. It is always good to start the rule implementation from the start of the tax year.
Assume that you do not identify the ‘disguised employees’ in your organization and do not follow the taxation procedures from 6th April 2021. If this occurs, you may face legal and financial complications in the following financial year. In the event that you meet the conditions of IR35 for two consecutive years, you will need to apply the rules on a different date.
To comply with this recently implemented anti-avoidance tax legislation, you need to first determine the employment status of a specific role or every contract you have with an agency or employee.
In order to support your decision, you’ll need to:
- Inform the employee and the person or agency with whom you have a contract of your decision regarding employment status.
- Record the reasons for your employment status determinations and your paid remuneration in detail.
- If disagreements arise from your resolution, prepare a strategy to deal with them.
The employer must deduct and pay taxes and National Insurance contributions to HMRC on behalf of all contract workers working off-payroll.
From 6 April 2021 onwards, all contract workers or intermediaries, as well as the agencies you contract, must provide their employment status and the reasons for it. Regardless of the resolution regarding off-payroll working rules, it is good to follow the same rule for all.
The step of notifying the employee that your determination has been made is very important, since you will be responsible for the employee’s tax and National Insurance contributions until you do so.
It is valid under the new rules to use an employment status determination statement issued before 6th April 2021, as it is helpful for determining the new tax rules. Any time there is a change in working practices or a new contract with a previous or current employee, you must follow the same rules.
IR35 Calculation
The IR35 calculation has eight steps. Each step, other than Step 7, is on cash basis for both tax and NICs. Records must therefore be kept on both a cash basis for IR35, and an accruals basis for accounting and other tax requirements such as corporation tax.
- Step 1 – deduct 5% from your off-payroll income
- Step 2 – add payments made directly to the worker
- Step 3 – deduct expenses
- Step 4 – deduct capital allowances
- Step 5 – deduct pension contributions
- Step 6 – deduct employer NICs
- Step 7 – deduct salary and benefits already paid to the worker
- Step 8 – deduct employer NICs on the deemed payment
It may also be helpful to use an IR35 Calculator to assist you. You can find several of these tools on the internet. However, when it comes to a company like ours, you can rely on us to provide you with a straightforward calculation.
IR35 Misclassification Risks: What Are They?
There is a possibility that you may be caught by HMRC if you do not correctly classify all your work contracts.
In the event of misclassification, you may be required to pay back taxes, social contributions, and pensions, as well as interest charges. Depending on the severity of the offense, there is the possibility of imprisonment or punitive payment.
Conclusion
As with other legislative activities, the enforcement of IR35 also requires proper understanding, communication of the upcoming IR35 changes, as well as appropriate technology solutions and professional services.
Employers can avoid any potential liabilities by implementing necessary steps ahead of time, educating their workforce, and using the appropriate tools in order to ensure the contract workers receive accurate information regarding the changes that will affect them.