The general election fast approaching. Self-employment has been high on the agenda, with several key political figures suggesting a review of off-payroll rules may well be on the horizon.
Everything you need to know about IR35
Whether you're an employer, an employee, a contractor or sole trader, understanding the changes coming in relation to IR35 is very important.
We’ve taken a look at some of the most frequently asked questions when it comes to IR35, along with why you need to have a good knowledge of the consequences of getting it wrong before you enter into a contract.
What is IR35?
IR35 is a piece of legislation which applies to a business and the people or companies they engage.
Before IR35 was introduced, HMRC was worried that a lot of people were engaging with businesses on a subcontractor basis through limited companies, often known as personal service companies (PSCs) to minimise their tax liability.
The problem is that if the intermediary business wasn’t there, their engagement would have all of the characteristics of an employer/employee relationship. This is known as ‘disguised employment’.
Some key terms you should know
Mutuality of ObligationWhether there is an expectation for both parties to provide and accept the work
ControlWhether or not there is an element of control from the contractor as to how they deliver their work
Right to SubstitutionWhether there is an expectation for the contractor to complete the work personally
Several pieces of independent research identified that employees were leaving their pay as you earn (PAYE) employment, only to return shortly afterwards to carry out the same role for the same company – This time using a personal service company.
To add to this problem, other employees were leaving their PAYE employment with a company, only to be re-hired through an intermediary business.
This resulted in the enabled employees and employers to avoid unwanted tax obligations, by reducing NI payments and minimising tax, without fundamentally changing the nature and conditions of the work carried out.
More concerns were raised in relation to the costs that come along with employee rights and benefits.
For example, employers are not only obliged to pay employer national insurance contributions (NICs) for their employees, but they also face costs for things like sick pay, holiday pay and pension contributions.
Engaging a contractor using a B2B contract removes these obligations.
When was IR35 introduced?
IR35 was introduced in 1999 and came into force in 2000. It originally focused on public authorities, aiming to target off-payroll working.
It provides a legal framework to help understand the nature of the relationship between the two parties involved.
IR35 is backed by case law, and the legislation is designed to help protect both workers' rights and prevent tax evasion.
Although IR35 started in the public sector, it will be extended to the private sector in 2020 and could have a significant impact on subcontractor income if it isn’t managed correctly.
When does IR35 apply?
Many businesses are keen to know whether their working relationships run the risk of being classed employer/employee rather than contractor/subcontractor. Generally, if you’re running a small business or are self-employed, you have nothing to worry about.
HMRC lists a number of characteristics which apply to self-employed people or small companies, which are outlined below.
In addition, there are also characteristics which define what an employee is. In some cases, people can be an employee for one company and work with another as a contractor at the same time. The IR35 rules help HMRC to understand which status will apply in any given situation.
Characteristics of someone who is self-employed or a contractor
There are lots of ways to identify whether somebody should be considered self-employed.
Although there are some exceptions, a self-employed subcontractor...
- Is generally paid a fixed price for the project, regardless of how many hours they need to get it done. Is able to exercise a ‘right to substitution’. This means they don’t need to personally complete the work, so long as the work is completed.
- Provides all the tools and equipment they need to get the job done. Can decide who they work for, what work they do, and when they do it.
- They are able to turn work down if they don’t want it. Will generally have more than one client.
- Is responsible for rectifying the work if it isn’t to the expected standard, without charging for additional hours.
- Will have to make their own arrangements for paying tax and NI. Will invoice for the work which has been completed.
Of course, not all these criteria apply to every self-employed person. If you’re involved in a business arrangement where many of these criteria don't apply, it's likely that the relationship could be viewed as falling within IR35.
Does IR35 apply to me?
There are several checks that you can carry out to determine whether you are genuinely self-employed from an employment status perspective.
The Government released a tool called Check Employment Status for Tax (CEST), which tries to help with the classification of your IR35 status. However, due to the wide range of considerations that the tool makes, the accuracy of the tool has been brought into question.
If you have any doubts at all, you should always speak to an expert.
If you need some help, we can carry out a free Supervision, Direction and Control (SDC) review for your business.
Whether you are engaging self-employed people, or working as a subcontractor, we can help you reduce any risks you might come up against.
Characteristics of someone who is an employee
When trying to understand whether you are an employee and where you stand in terms of employment status, there are a few things that will be considered. We’ve outlined them below.
Remember, it just because there is a contract between you and the employer/employee, it doesn’t mean that you’ll be exempt from IR35 review and potential reclassification.
To be classed as an employee, somebody will generally...
- Be the person completing the work. They must be the person the contract is with, usually mentioned by name.
- Turn up for work when at an agreed time unless they have a specific reason not to. For example, if they're sick or on annual leave.
- Be entitled to a range of work-related benefits including things like sick pay, statutory maternity pay, holiday pay and company pension access.
- Have to work in a particular place.
- Have a line manager who will supervise their performance and workload and tell them how to do the job.
- Have their income tax and national insurance deducted before they receive their wages.
- Tend to work for one main employer. If they have an additional job, it will be something different from their usual job and will tend to run alongside it with it, rather than consecutively.
Remember, somebody doesn't have to meet every single one of these things in order to be considered an employee.
What does it mean to be inside IR35?
To be ‘inside IR35’ means that for tax, the relationship between the two parties is considered one of an employer and employee. That means that IR35 regulations will cover it.
How can I stay outside IR35?
Because the tax implications that come out of an employer/employee (PAYE) relationship are much more significant than they are between two businesses, people are often eager to ensure what they do doesn't fall under the IR35 umbrella.
The reality is that if you operate as a genuine business, you’re likely to be classed as one, so long as your working practices fit within the rules. In situations when the type of relationship that exists isn’t immediately apparent, a Tax tribunal or court will make a decision.
Any judgements that are made will be done so, irrespective of your current tax status.
For example, an operative might pay taxes as a self-employed person, but could still be found to be an employee by a tribunal if specific characteristics are/are not met.
What happens if you fall within IR35?
If it is decided that an individual falls within IR35, HM Revenue & Customs (HMRC) can demand retrospective considerations for both tax and National Insurance.
For income tax, HMRC can demand retrospective payment for the previous four years.
For National Insurance, retrospective contributions can be demanded going back up to six years. Unfortunately, these can add up!
Companies caught by IR35 can end up paying significant amounts of arrears.
How to avoid getting caught out by IR35
If you are worried about being caught by IR35, it's essential to speak to an expert as soon as possible.
So long as you’re operating as a business and can show that you meet the characteristics outlined above, it's unlikely your work will be classified as inside IR35.
Always keep a suitable paper trail so you can show evidence of your contractor status.
This evidence may include:
- Contractual proof that the work can allow for substitution – In other words, no specific person is named to carry out the work
- Showing that you have refused work from the client and have therefore avoided mutuality of obligation.
- Keeping copies of any invoices issued
There is a lot of complicated case law relating to IR35. With IR35 most likely coming into full force across the private sector from 2020, it's important to get advice from a skilled legal professional who understands this difficult piece of legislation.
Need some help with IR35? Get in touch, and we can help...