HR Snapshot #7: Demystifying IR35 - A guide to working with Contractors and Freelancers
Posted on 16th July 2019 at 09:42
The UK Government has just confirmed IR35 will apply to private sector from 2020. Medium and large businesses have nine months to prepare for off-payroll legislation or risk significant impact on business performance and talent pool.
Here's our latest HR Snapshot, a 5 minute read on IR35 written by Kellie Calvert, MCIPD our Associate HR Director.
Understanding IR35 – A 5 Minute Read
1. What is IR35?
IR35 is tax legislation that is designed to combat tax avoidance by workers supplying their services to clients via an intermediary such as a Limited Company (Ltd) or Personal Service Company (PSC), who would be classified as an employee if the intermediary was not used. These workers are called ‘disguised employees’ by Her Majesty’s Revenue and Customs (HMRC).
In 2017 the UK Government made changes specific to the Public Sector and now plan to roll out similar changes to the Private Sector in April 2020.
2. What is changing and what do I need to do?
Until now, in the Private Sector, the contractor has been responsible for deciding if the IR35 rules apply or not, which has an impact on the way that they tax themselves. The change now requires the end client or ‘Fee Payer’ to make the decision on whether the IR35 rules apply to the assignment. This is known as being inside or outside IR35.
If the rules do apply to the assignment (Inside IR35) then the Fee Payer (whoever is closest to the Limited Company in the contractual chain and making the payment to the Limited Company) must make a deemed payment to HMRC including PAYE Tax and National Insurance contributions before paying the net amount to the Limited Company.
If the decision is that the rules do not apply (Outside IR35), then the Fee Payer would make a normal gross payment to the Limited Company with no deductions.
3. Who will these changes affect?
It is likely that any medium or large businesses as defined by the Companies Act 2006 will have to implement the new rules. Small businesses in the Private Sector will continue with the existing rules. Smaller businesses are defined as those which satisfy two or more of the following requirements:
• Turnover no more than £10.2m
• Balance sheet total no more than £5.1m
• No more than 50 employees.
4. Determining the IR35 status
For a Fee Payer to decide if a contractor is genuinely self-employed (Outside IR35) or a ‘disguised employee’ (Inside IR35) they must consider a number of factors. Some of the key factors that are considered, based on existing case law, are ‘Control’, ‘Personal Service’ or ‘Mutuality of Obligation (MOO)’.
Most contractors supplying services to a Fee Payer will be highly skilled in their area of expertise. As a result, they should not be subject to control from the Fee Payer in relation to how they deliver the services they have been engaged to provide
If a Fee Payer has the ability to and in reality, does dictate the how, when and where elements of control, then it could be argued that the PSC/Limited Company is under control of the Fee Payer.
A Fee Payer simply reviewing the progress of services that are being delivered would not be considered on its own as control.
• Personal Service
Where a contractor is operating outside IR35 there should be a ‘right of substitution’ clause in the contract. However, it’s not enough just to have this clause in the contract and it must be reflected in the working practices of the arrangement; meaning that if a substitute was provided at any point, that substitute would be accepted by the Fee Payer.
• Mutuality of Obligation (MOO)
This examines the obligation of the Fee Payer to provide the contractor with work on an ongoing basis and whether or not the contractor is obliged to carry out that work. A genuine self-employed outside IR35 setup would see the contractor engaged for a specific project or piece of work and if anything else is offered, the contractor would not be obliged to accept it. If they do, this could be acceptable but would need to be agreed under a separate contract, specific to the new piece of work or assignment.
5. Reasonable Care
In order to limit your risk of financial penalties, it is important that you follow a documented process that demonstrates that you have applied reasonable care when making your decision on IR35 status. Reasonable care was added to the legislation before the rollout to the Public Sector to ensure that hirers take reasonable care in making their decision on the status of an assignment, a result of some organisations ‘blanket’ decisions and saying that everyone was to be deemed inside IR35 or that Limited Companies could no longer be used. This was not in keeping with the intention behind the legislation and the reasonable care element was added to prevent this.
Ensuring you apply reasonable care may also provide some level of protection against incorrect IR35 determination. For example, if you decide that a contractor is Outside IR35, but on subsequent audit is found to be Inside IR35, the question then arises as to whether an incorrect determination was made, resulting in the Fee Payer becoming liable for any income tax that should have been deducted. However, so long as the Fee Payer can demonstrate they have taken reasonable care in deciding, a subsequent re-characterisation does not in itself result in the Fee Payer becoming liable. Instead, documentation e.g. correspondence with the fee payer and/or contractors explaining the reasons for the determination, can be used as protection.
It is therefore important that you evidence your IR35 determination process and follow a defined procedure each time you engage a contractor and conduct periodic reviews for the duration of the contract.
6. How to prepare
Firstly, make sure you can identify how many contractors you have within your organisation; and have a very clear understanding of how they are engaged. We would suggest undertaking an audit of all contractors’ agreements, followed by an honest assessment of how they actually work on a daily basis. A good starting point would be to use the criteria as set out in Point 4.
Next, use the CEST (Check Employment Status for Tax), which is a HMRC tool that either the end client, contractor or agency can complete to help determine the IR35 status. The output, once the online process has been completed, is a determination confirming the IR35 status and HMRC have said they will stand by that determination if the information that has been entered was accurate. It is important to note that although anyone in the chain can complete the tool, the responsibility is on the end client (Fee Payer) to make the determination on the IR35 status.
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