Recent changes to this complex legislation have resulted in considerable confusion and upheaval for contractors. With further changes confirmed for 2020, it’s crucial that contractors keep themselves up-to-date on all developments and how they might be affected by them. Umbrella Exchange’s guide to IR35 gives contractors a concise yet comprehensive overview of this important set of regulations.
An overview of IR35
IR35 is a tax law announced in 1999, which took effect from April 2000 as part of the Finance Act. Formally known as the Intermediaries Legislation, IR35 was introduced to prevent people who are effectively permanent employees working through an intermediary (a limited company or personal service company) in order to pay less tax.
Although the legislation has a legitimate role to play in defending both workers’ rights from unscrupulous employers and HMRC from lost tax revenue, critics of IR35 have claimed that the legislation is confusing and poorly implemented by HMRC.
When working under the legislation, contractors are expected to pay the same taxes as employees, but without any of the safety, security or statutory benefits that employment brings.
In April 2017, IR35 rules changed for public sector contractors, making the client or agency, rather than the contractor, responsible for deciding whether a contract was ‘inside’ or ‘outside’ IR35.
The reforms lead to some public sector organisations announcing a blanket decision not to hire contractors working through limited companies, in order to ensure IR35 compliancy. Many public sector contractors responded by exiting the public sector altogether, leaving organisations such as the NHS at risk.
Despite widespread opinion that HMRC’s online assessment tool, CEST, is not fit for purpose, the government announced that the legislation would be rolled out to medium and large private sector firms in April 2020. This will mean that private sector businesses will be responsible for deciding if IR35 applies to each contract.
Faced with an unreliable assessment tool and inadequate guidance, many businesses have already started taking measures to reduce their liability risk. Large scale businesses such as Lloyds, Morgan Stanley, Tesco Bank and GSK have all announced that their contractors must go on the payroll.
This means that contractors working for these companies can no longer work through their limited companies. They can either choose to go permanent (if their skills are required), leave their contracts, or find a reliable umbrella company to work through.
As the reformed legislation will be implemented in both sectors, contractors working through a limited company are likely encounter difficulties. It’s therefore advisable for contractors to engage the services of a compliant umbrella company, at least in this interim period, while businesses attempt to familiarise themselves with legislation.
Contracting through an umbrella company will allow contractors to keep working on contracts of their choosing. As PAYE workers, they will be fully complaint with IR35 legislation, and therefore with the requirements of their clients.
- Introduced in April 2000.
- Reforms to public sector contracts in April 2017
- 2018 autumn budget announces reforms will apply to private sector in 2020
- If you are caught inside IR35 you will be deemed to be an employee and subject to full PAYE and NIC. HMRC can go back at least six years to evaluate past contracts
- Applies to the individual contract, not the contractor
- Seek professional advice to ensure you understand your risks
Inside or Outside IR35?
IR35 involves applying three key concepts to determine the employment status on any given contract; these are Control, Substitution and Mutuality of Obligation. These principles examine the way that contractual work is carried out, in order to establish the true nature of the relationship between the hiring organisation and the worker.
- Control: what degree of control does the client have over what, how, when and where the worker completes the work?
Most genuine contractors will exercise a high level of control over their work practice. Typically, they need minimal supervision and won’t be expected to conform to standard working hours at a designated place of work.
- Substitution: is personal service by the worker required, or can the worker send a substitute in their place?
A contractor has the right to send such a substitute in their place and also to engage subcontractors to carry out parts of the contract if necessary. In contrast, a contract that requires the work to be carried out by a specific individual points to disguised employee status.
- Mutuality of obligation: is the employer obliged to offer work that the worker is obligated to accept?
Under normal terms of employment there’s a mutual obligation for the employer to provide continuous work and for the employee to accept it. This obligation doesn’t apply to contractors, who typically work fixed term contracts with a start and finish date. Contractors who regularly work for the same client on new or ‘rolling’ contracts could be classified as employees under IR35.
How can contractors safeguard themselves?
HMRC have stated their expectation that people take ‘reasonable care’ to comply with the tax regime. Demonstrating reasonable care could include the following:
Keep your paperwork in order: Keeping organised and comprehensive records relating to your assignments will help contractors to file detailed and accurate self-assessment tax returns. In the event that HMRC decides to raise an inquiry, these records could provide invaluable evidence.
Check your contract: A contractor should always take the time to read over their contract before signing it. Wherever possible, contracts should include a right of substitution clause stating the contractor’s right to send a substitute in their place or to engage a subcontractor.
Communicate with your agency and/or client: Open communication is increasingly important between all parties who are negotiating the contract to ensure that all are in agreement regarding the contractor’s employment status.
Consider a confirmation of arrangements letter: Where an agency or client uses a generic contract, contractors can use a confirmation of arrangements letter, which asks the client representative to confirm the most important points about their contract and working arrangements.
Seek professional advice: When in doubt, contractors should seek professional advice and consider a contract review service for each assignment.
Avoid acting like an employee: When determining employment status, HMRC examines the day-to-day activities of the contractor. In order to differentiate themselves, contractors should avoid typical employee behaviour, such as always eating in the staff canteen or accepting benefits such as sick pay or holiday pay from the client.
HMRC offers a self-assessment tool to help contractors decide if IR35 applies.
If IR35 is found to apply to a contract, HMRC can go back at least six years in order to evaluate previous contracts to see if the legislation applies. This means that HMRC can demand income tax and NICs, plus penalties and interest.
What to do when IR35 applies
When IR35 has been found to apply to a contract, then you (or the fee payer) need to calculate what’s known as the deemed payment on your limited company income. This means that you deduct your Pay As You Earn (PAYE) salary, plus any pension contributions.
The remaining amount is treated in the same way as salary paid by an employer, so you must calculate the additional tax due. The most straightforward solution is to pay out all of your limited company’s fees minus legitimate expenses and pension contributions as a PAYE salary. Since you are paying yourself like an employee, then IR35 won’t apply.
Another option is to join a Compliant Umbrella Company. The Umbrella Company becomes the contractor’s employer, paying them through PAYE. Due to the on-going working arrangements, agencies are more likely to suggest the Umbrella Company option for contractors. To find out if an Umbrella Company would suit your needs, read our guide here.
Expenses and pension contributions
Pension contributions: Contractors working under IR35 in both the private and public sector are able to continue claiming tax relief on pension contributions made by the limited company on the contractor’s behalf.
Expenses: Although the 5% expenses allowance does not apply inside IR35, contractors can still claim the same deductions against their earnings that they would be entitled to if they were normal employees working for that company.
Keep updated with IR35 developments though our latest news articles.