The ins and outs of IR35
This section covers what the IR35 rules are, who they apply to and why they are in place, giving businesses a well-rounded view on the topic.
What is IR35?
IR35 is the formal name for the rules for work that is considered off-payroll. It emerged as part of the 2000 Financial Act and refers to tax laws that were implemented at the time. The “Off-Payroll Tax” is the successor of IR35. It was introduced seven years later, in April 2017. Its objective is to clarify the original legislation that had become complex and difficult to enforce. When talking about IR35, the “Off-Payroll Tax” is assumed to be part of the discussion and one term can be used to cover both legislations.
Usually, the distinction between employees and contractors or freelancers is simple. However, there are some subtleties that employers must be aware of in order to ensure they do not end up in HMRC’s bad books. The rules state that a worker, known as a contractor, should pay the same amount of Income Tax and National Insurance as an employee in the business.
Who do the IR35 rules apply to?
When it comes to IR35 rules, it is essential to understand who they apply to. Those who might be affected by the rules meet the following criterion:
Workers
Workers deliver services to a client. Workers who are subject to the rules are likely to be providing their services through a limited company or a personal service company (also called PSC). They may also deliver the service through a partnership or another individual.
Clients
Clients get services from a worker through their intermediary. They are the person who will be receiving the service or the defined worker. Clients are also called the hirer, the engager or the end client.
Agencies or other types of suppliers
These types of suppliers provide workers with services through intermediaries.
It is essential to note that the rules are different depending on the size of the business. Small businesses and large corporations are subject to different guidelines.
When do the IR35 rules apply?
Now that we know who the IR35 and “Off-Payroll Tax” rules apply to, let’s look at when these apply in the section below. Defining if the worker is employed for tax purposes will depend on the situation of the client. For example, there are differences if the client is from the public sector, if they are a private organisation or if they are a small business.
The client is often the one responsible for determining the employment status of the worker. However, as mentioned, the rules can be complex and vary depending on the circumstances. For small and medium businesses that are outside the public sector, the worker’s intermediary is responsible for deciding the employment status. The intermediary decides if the rules apply or if they do not.
As an aside, size only influences the rules when it relates to the client. It does not impact the results when it comes to agencies. This means that all agencies, regardless of their size, are responsible for defining where the rules apply.
Why was IR35 implemented?
Seeing how complex the rules can be, you may wonder why they were put in place. IR35 is part of an effort from HMRC to stop contractors and businesses working together as employers and employees. By doing so, they were avoiding certain taxes. Employers saved by avoiding a share of National Insurance Contribution. They also did not have legal obligations that apply to employment rights and associated benefits. On the other side, contractors could pay less tax on their income.
More on the personal service company and IR35
The personal service company is one of the possible structures used by freelancers or contractors. With it, they operate as a limited company. It is essential to know about the personal service company when it comes to IR35. For contractors, working under a limited company adds prestige to the services and also separates personal finances from business finances and as such allows to get paid in a more tax-efficient way.
A personal service company, also called PSC, is a company that has just one person. The sole shareholder is the company director. Working under a PSC allows contractors to work with clients who only work with limited companies. In that instance, the PSC is legitimate.
The IR35 rules were implemented to ensure that those who operate under a personal service company do not do so for tax evasion purposes. There has to be a legitimate reason for the PSC.
What are the penalties when someone gets caught?
There are penalties for those caught breaching IR35. These consequences can have a deep impact both on the business and the contractor themselves. When it comes to those penalties, knowing if the status was incorrect out of carelessness or if it was deceptive makes a huge difference to the outcome. For example, contractors who did not pick the right employment status accidently or because they did not know will be liable for 30% of their unpaid tax bill. The penalty is much higher for those who were deceptive and knew they were breaching IR35 but did not take action. If they still operate as self-employed, they can be liable for 70% of their unpaid tax bill.
For employers found to be deceptive, the punishment is even greater. They can be taken to tribunal by HMRC and may be asked to foot the bill they have avoided.
How can businesses or contractors fail IR35 tests?
The section below provides tips for businesses and contractors to find out if their client or worker are in “disguised employment”. Let’s look at the factors to consider:
Background of the role or content of the work itself
If a contractor is doing the work that an employee was previously delivering, there might be a risk of disguised employment.
Businesses subject to previous investigations
When a business has already been subject to an investigation, it is more likely that they will be on HMRC’s radar. Companies who have already been reprimanded for hiring contractors in breach of IR35 are likely to be looked into on a more regular basis.
Legitimate contracts
A contract between a freelancer and a business needs to be created or checked by a professional. Is this is not the case, it is likely that there is a breach of IR35.
High levels of control
If the employer is highly prescriptive on the tasks that need to be delivered, the way it should be done, the contractor’s lunch breaks and more, it is likely that there is a breach. The behaviour raises red flags.
Substitution of the contracting work
When a contractor delivers on tasks that cannot be replaced by someone else, this is a breach of IR35.
Evolving under a Mutuality of Obligation (MOO)
In the partnership between contractors and businesses, there needs to be mutual agreement. The contractor delivers a service and the business expects the work requested to be completed. They both have obligations to each other.
Invoice structure
Freelancers typically invoice clients when they reach milestones. This can be at the end of each month or when completing a project. The invoice contains details of the hours or the number or projects and the price per unit. When the contractor’s income from the business looks like a salary due to its frequency, this can be a breach of IR35.
Personal or client equipment
When a freelancer or contractor is required to use the client’s equipment to conduct the work, unless there is a legitimate reason, they will breach IR35. Legitimate reasons can be related to safety and security. If this is not the case, the partnership will shift to an employer-employee relationship.
Integration into the business
Contractors will easily fail IR35 if they are considered to be employees. For example, if they are very comfortable in the office, know their way around, know all their colleagues and behave like an employee, it is likely that they should be an employee and not a contractor.
Intentions of client-contractor relationships to be expressed in writing
Contracts between businesses and contractors should be explicit and clearly state that the relationship is not an employee-employer relationship but a contractor-client relationship. This simple action can help stay compliant with IR35.
When it comes to employment law and particularly the IR35 rules, it is critical that businesses who work with contractors are aware of the details of the law. They can use the IR35 calculator to know what IR35 tax would apply to them. Investing time to understand these rules will save a lot of hassle and potential penalties for the business.
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