What is IR35?
IR35 refers to the Off-Payroll legislation which was introduced in the UK in the early 2000s in an attempt to tackle tax avoidance. The legislation aims to prevent tax avoidance where individuals who should be recognised as an employee for the purposes of tax, instead supply their services through an intermediary (such as a personal service company (PSC) like a limited company), and treat themselves as self-employed. In doing this, the individual can avoid liability for income tax and national insurance (NI).
Does it apply to me?
In the private sector, the current position is that the responsibility for assessing and determining an individual’s employment status for tax purposes falls on the individual themselves.
For example, if you are supplying services to a third party (the engager) through a PSC, the burden is on you/the PSC to assess whether or not you are an employee for the purposes of tax and therefore whether or not you should be paying income tax and NI. The engager (or the agency should there be one) does not currently have any requirement to assess employment status, nor do they have any tax liability should HMRC disagree with the assessment.
What are the changes coming into force in April 2021?
From 6th April 2021, this is set to change. The government is reforming the IR35 rules in the private sector, to bring them into alignment with the rules in the public sector. From 6th April 2021, all medium or large-sized private sector businesses will be responsible for determining the worker's employment status for the purposes of tax.
To classify as a small company for the purposes of IR35 and therefore be exempt from the updated legislation, a company must meet at least two of the following criteria:
- Annual turnover of £10.2 million or less;
- £5.1 million on your balance sheet or less; and
- 50 employees or less.
If your business does not meet at least two of these criteria, then they will be classed as a ‘medium or large-sized business’ under the Companies Act 2006 and the updated IR35 legislation will apply.
Following the change, it will be the burden of the engager to assess and determine the individual’s employment status for tax purposes and to pay the PSC accordingly. The engager will also now be liable should HMRC deem the determination incorrect.
Should there be other parties in the supply chain between the engager and the PSC, such as an agency, it is still the responsibility of the engager to assess and determine the employment status. The below diagram shows how the ‘engager’, the one receiving the services directly, will now be the one responsible for determining the employment status of the individual regardless of how many organisations are between the engager and the individual in the supply chain. The engager is then required to pass the outcome of their assessment down to the company paying the fees to the PSC, which would usually be the agency. Should the agency be unable to pay the tax for some reason, the liability then falls back to the engager (or the next in the supply chain should there be more than one agency involved).
What are the consequences of not complying?
Should a business fail to analyse the relationships that they have with their contractors and refuse to provide employment status determinations, or indeed make incorrect determinations without proper consideration, then there is a risk that they will be subject to large financial penalties from HMRC.
Following the incorporation of the updated legislation, HMRC will have the power to investigate the employment status of off-payroll workers in the private sector and issue a notice requesting the unpaid NI and PAYE tax should they find that a business has incorrectly categorised the employment status of one of their workers.
In addition to the outstanding NI and PAYE, HMRC also has the power to issue late payment fines and interest to the engager, along with a penalty that can be up to 100% of the outstanding liability. This penalty will be based on the circumstances as a whole, taking into account what steps have been taken by the engager in order to determine the employment status of the worker.
Further to the cost consequences above, there is also likely to be reputational damage done to the business and a competitive disadvantage.
How do we prepare for this?
Ahead of these upcoming changes, a lot of engagers and agencies in the private sector are scrutinising their business relationships with the PSC’s they engage with. Even in situations where there are written contracts which demonstrate that there is no employment relationship for the purposes of tax, remember that HMRC will look beyond this and look at the true nature of the working relationship. If the contract does not reflect the true position, it may be disregarded.
In order to prepare for the new rules, engagers and agencies should do the following:
- Conduct a full audit and review of their business relationships with any contractors that they engage with in order to consider and determine whether any of these will be subject to the legislation;
- If Contracts exist, consider whether they are a true reflection of the working relationship. If they are not, consider redrafting them to ensure they are more accurate;
- Contact the relevant contractors to discuss the determination of their employment status, so that you can iron out any disputes in relation to this prior to the legislation coming into force;
- Prepare and update your payroll and HR systems for a potential change in the way you need to pay contractors; and
- Prepare and budget for the increased costs potentially involved as contractors may wish to raise their prices in order to take account of the tax to be paid.