IR35 Advice

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IR35 in the private sector: A guide

We're constantly updating our list of commonly asked questions from freelancers and the self-employed to reflect the latest government policy and advice. 

IR35 guide

Frequently asked questions about IR35:

 

Paul Mason from Markel Tax answers common questions from IPSE members.

Determining employment status

It should be stressed that we are only considering employment status from a tax perspective (although the approach to determining is largely the same for employment law) because the matter is black and white: you are either an employee or you are not.  The problem lies in the subjective nature in arriving at the answer!

The other point to make is that an engagement which is deemed “inside” (or “caught by”) IR35 from April 2021 in the private sector (or currently deemed inside in the public sector) does mean that the contractor’s engagement is taxed on the same basis as PAYE, but it does NOT give the individual any employment rights.  The individual is an employee for tax purposes only.

So, how do we determine employment status? We ask the question: “Does the engagement look like an employment relationship?” and the reason that we take this approach is because of the 1968 case of Ready Mixed Concrete v The Minister of Pensions and National Insurance in which the Judge established the key factors that make you an employee:

  1. You must be required to provide your personal service – you and no-one else will do the work
  2. You are controlled in the manner in which you do the work
  3. Mutuality of Obligations (MOO) exists; i.e. there is an expectation that work will be offered and accepted

If all three factors are present, the contract is one of ‘service’ (employment), but if one these is missing then it cannot be a contract of employment, so the relationship must be one for the provision of services or akin to self-employment.

Despite the recent referees’ case (PMGOL) focussing on a lack of mutuality, MOO is still the most difficult of the three to argue and so it is much better if as a contractor/freelancer, you can demonstrate that your personal service is not a requirement of the engagement and/or you determine how the work is done.

Personal service/substitution and IR35

The term Personal Services Company (PSC), which is not a legal definition, but a term used to define a company which typically has the one fee earner and often one shareholder/director, although many PSCs will have joint shareholdings with partners/spouses.  It does not mean that your personal service is a requirement of the engagement.

It is possible to deny that personal service is required without sending a substitute, although actually sending someone else in your place – unless somehow manufactured – would be conclusive proof that personal service is not a requirement of that engagement.  However, when it comes to substitution, personal service would be denied if you had an unfettered/unrestricted right to substitute (your client would expect the replacement to have the skills, qualifications and experience to do the work and should have the right to refuse the substitute if they don’t). In short, the client can expect the substitute to have the relevant skills, but this doesn’t diminish the unfettered nature of the right to send a substitute.

One recent IPSE webinar attendee made the point that their contract required them to be responsible for paying the substitute if one was sent, and did this happen in practice. One of the key elements of substitution is that your company remains in the contractual chain and is therefore responsible for the replacement including the payment of the substitute’s fees.  Moreover, if your company does engage a substitute make sure that all your contractual requirements are reflected in the arrangements with your substitute.  If your company has to have Professional Indemnity of £2 million, make sure that your substitute has the same level of cover; if your company is required to rectify defective work at your own cost, make sure the same clause is in your contract with the substitute.

Do we see substitution happen a lot in practice? No, but from an IR35 perspective it is the right to substitute which is just as important.

Mutuality of Obligation (MOO)

The issue of mutuality is a thorny one: as one question put it: if you are signing a contract to provide services for a period of time, is there not an expectation that you would see the contract out? In reality, if a contractor has a history of not completing assignments, then offers of work will soon dry out.

However, you have to look into the detail: if the work is for X months with no deliverables, then is the freelancer just at the beck and call of the end client moving from task to task and being renewed until they look like part and parcel of the end client’s business? If you are on an engagement of six months with three months’ notice, once you get to the start of month four you are contractually obliged to complete the term.

On the other hand, if you are not obliged to be working for the client on any given day or the client terminates at very short notice and there is no expectation that you will be offered (or accept) other work, then clearly no mutuality exists.

There were a couple of question around the term personal services Company (PSC), which is not a legal definition, but a term used to define a company which typically has the one fee earner and often one shareholder/director, although many PSCs will have joint shareholdings with partners/spouses.  It does not mean that your personal service is a requirement of the engagement.

Does IR35 apply to sole traders?

IR35 does not apply to sole traders. IR35 is the commonly used term for the Intermediaries Legislation which came into force in April 2000.  The intermediary can be a partnership, but is usually a limited company – the contractor’s Personal Services Company – and the objective of the legislation is to require HMRC to create a “hypothetical contract” and effectively look through the intermediary in the contractual chain and ask what the relationship would look like if there was no intermediary you were engaged directly by the end client.

If you are engaged as a sole trader there is no intermediary, the client is engaging you as an individual.  If HMRC can argue successfully that arrangement is in fact one of employment, with no intermediary in the contractual chain, you can only be an employee of the end client.  If that is the case, HMRC have determined that the end client failed to operate PAYE on your earnings and will be seeking arrears of tax, employee’s National Insurance and employer’s National Insurance Contributions, plus interest and potentially a penalty.  For these reasons, end clients have not generally sought to engage people as sole traders.  If freelancers were engaged through their own limited companies, the status risk remained with the freelancer’s company.

If you are working for a number of end clients concurrently and you are therefore juggling work and determining when work is done and which client you want to work for on any given day, then that would be a positive, but not necessarily wholly conclusive: is it still only you they want? Are they determining how the work is done even though you may have a significant say in when it is done? There could still be mutuality in that once you have accepted a particular project you have to see it through to conclusion.

That is why tribunal judges also look at the whole picture and will still consider secondary factors like financial risk and whether you paint a picture of bring in business on your own account.

Going back to working for other clients. If you work X months for client A and then Y months for client B, that is not necessarily conclusive that the relationship is akin to employment.  IR35 has to be considered on a case-by-case basis and on each occasion, you start by reviewing the three key factors.

This leads neatly on to a question about how and when IR35 should be addressed.  Certainly the key factors should be referenced in the contractual terms if the arrangement is to be viewed as an engagement between independent contracting parties.  And the working practices must support those terms.  If you are unsure whether your contract is fit for purpose, then IPSE offers a contract review service, but I must declare an interest in that Markel Tax provides the service.  If you don’t have a contract, then as an IPSE member you can access templates, but make sure that you get some professional advice to ensure that the terms are suitable for the services which you provide.

Has coronavirus impacted IR35 assessments?

One person recently asked if Covid-19 has helped or hindered contractors from purely an IR35 status perspective, as it clearly has resulted in a reduction in available roles. There is an argument that engagements being cut demonstrates a lack of mutuality, but I would want to be able to demonstrate a lack of personal service or (preferably ‘and’) that deny that the end client has the right to control how the work is undertaken. This leads on to a point noted about working from home: there has been a realisation by end clients across the piece that you don’t have to be able to see your contractors (or indeed employees) every minute of the working day to be satisfied that they are doing a good job. The outcomes should be what the end client is measuring, not the visibility of its external resources.

I am not sure that I can answer the pandemic issue, but in respect of private sector changes, it won’t spell the end of contracting.

There will be many contractors who will see a worsening of their tax position and in some cases they will feel justifiably aggrieved at the way their end clients have approached the changes. There will be contractors who find themselves forced to take employed roles – and in some cases that will reflect the reality of the situation – and some will be engaged by umbrella companies.  However, the UK economy is built upon a flexible labour force and small business, so freelancers will still be required in large numbers, if not the volume we have seen in recent years.  Moreover, if the experience of legislative changes in the self-employment market is anything to go by, the initial knee jerk reactions begin to be reversed when engagers realise that their competitiveness is being hit by an overly risk averse approach. 

What is the effect on expenses of being deemed inside IR35 from April 2021?

Currently, in the private sector if a contractor deems that their engagement is inside IR35, they must undertake the deemed calculation which allows a 5% deduction for general expenses from the fee billed on that engagement in a particular tax year and also enables the contractor to claim tax deductions that an employee could claim such as subscriptions and protective equipment as well as personal pension contributions.

The remainder is then taxed and must include Employers’ National Insurance contributions and then the employees’ NIC and PAYE tax deductions that an employee would suffer. The detail of how the calculation is made can be found here.

If an engagement is inside (caught by) IR35, you cannot claim your travel and subsistence expenses in relation to attending the end client’s site; in the same way that an employee cannot claim their commute.  If your role requires you to travel on behalf of the role, for example travelling from the end client’s site to another site for their business, then these costs can be claimed over and above the 5% general deduction.

From April 2021, the private sector will fall into line with the public sector and the 5% general allowance is removed and all that can be claimed is what an employee could claim on their tax return which would include subscriptions, protective clothing, pension contributions and expenses incurred in the fulfilment of your role. 

These could, with agreement, be reimbursed by the end client otherwise you will have to claim those – including pension contributions – via your income tax self-assessment return.

The result is that no other expenses can be claimed and any payment from the fee payer will have tax and NICs (both employers’ and employees’) and apprenticeship levy (if applicable) deducted.  Essentially, every single penny will be accounted for and you will have no profit in your company against which to set off your expenses of running your company. These will be coming out of your own pocket; so it is small wonder that contractors in the public sector who realised that all their engagements were going to be inside IR35, determined that there was little point in continuing to trade through their company.

Could I be taxed twice?

The answer is no in that you can extract the income you have been taxed on from your company without further being taxed.  On the other hand, HMRC won’t allow your company to claim the PAYE deducted as a corporation tax deduction either.  I am going to demonstrate some severely sloping shoulders at this point and suggest you speak to your accountant about how this needs to be shown in your company accounts as the IR35 element of this query I can answer, the accounting treatment is for others to fathom!

Who decides my IR35 status?

The key to the process and the starting point for HMRC to police the off-payroll IR35 legislation will be establishing whether the end client has taken reasonable care in arriving at the status decision and has then fulfilled the requirements of the legislation.  One of the questions asked was what could a contractor possibly do if the client hasn’t taken reasonable care? Other than refuse the role?

I don’t wish to dodge the question, but with any piece of tax legislation, the questions always have to be: “Does it have the teeth?” and “Are HMRC willing to police it?”

In answer to the first question, the foundation stones of the updated legislation – and missing from the 2017 off payroll public sector legislation – are ensuring that:

  • reasonable care is taken by the end client in making the status decision
  • the status decision is properly passed down the recruitment chain
  • there is a “client-led disagreement process” (the freelancer’s opportunity to challenge the SDS decision)

The legislative requirements around this process are designed to make it unattractive for the end client in particular to deviate from the process.

In summary, the end client’s responsibilities are:

  • Taking reasonable care about making a status determination

This means understanding IR35 sufficiently to make a decision – and the larger the end client, the more HMRC will expect from them in this regard – and not making the blanket decisions felt to have been prevalent in the public sector, although HMRC deem it acceptable to take a common approach to a role where the terms and conditions and working practices are the same for a number of contractors engaged to do the same work.

  • Issue an SDS to the correct parties with an explanation for the decision

A Status Determination Statement must be created and issued to the worker and to the agency below the end client in the contractual chain if there is one.  It must contain reasons why the decision has been made – whether inside or outside IR35 – and we believe that it should consider both the contractual terms and working practices, and certainly not be generic. Prior to the legislation being deferred to next year, we saw an SDS issued, which stated in relation to in-business matters that ‘one or more factors did not apply’ and believe that this was not sufficient to reference the contractor’s circumstances.

  • Have a “Client-led” disagreement process

A contractor – but not an agency – has the right to challenge in writing the decision made by the end client. The client must respond within 45 days, giving a ‘reasoned response’.  Where clients have gone about the process correctly, it is difficult to see how the response will differ from the initial decision, but not responding would constitute failure to take reasonable care.

If the end client fails in its duty to undertake any of the above, then the client has not taken reasonable care, and the responsibility for the deduction of tax and NICs and payment of apprenticeship levy and paying these to HMRC is the client’s. This is the case even if another party has already made deductions in line with the original determination. Corrections for that other party can be made as the client will be required to meet the liability.

Whilst the penalties for the end client are draconian, this may still not satisfy the webinar attendee’s question and so we move to the issue of policing the legislation.

No-one yet knows how HMRC will undertake their compliance work, although with these requirements to take reasonable care, it makes sense that HMRC will start with the end client engager. If HMRC conclude the end client has complied with its legislative responsibilities and taken reasonable care, but do not agree with the decision reached, then the fee payer – if the end client is not engaging the PSC directly – would be the next call as they will be responsible for the liability. 

Is it my responsibility to make the IR35 status determination statement?

We will start by considering which entities do NOT have to make the decision: small companies and clients based wholly overseas.

Small companies

Small companies (as defined by s382(2) of CA2006):

  • Turnover of no more than £10.2 million
  • Balance sheet total of no more than £5.1 million
  • No more than 50 employees

are exempt from the legislation, which HMRC have stated excludes 1.5 million small companies. However, HMRC has also clarified that where a small company is part of a group, the group situation has to be considered; i.e. no setting up a small company to engage all of your contractors. I would expect that HMRC may focus on some of the small consultancies which may spring up to ensure that they are not being used to avoid the end client’s obligations.

In short, the responsibility for issuing an SDS never rests with a PSC.

Finally, the size conditions only apply to end clients. The size of the agency, fee-payer/deemed employer is not relevant in determining whether the off-payroll working rules apply or not, so a small-sized agency would still be responsible for applying the off-payroll working rules, even if they are not medium or large-sized.

Overseas clients

Where an end client is based overseas, then HMRC cannot compel them to make an IR35 status decision as HMRC’s jurisdiction does not extend beyond these shores.  Therefore the first ‘onshore intermediary’ has the decision-making responsibility.

That could be a UK-based recruitment agency, but if your business is engaged by an overseas client directly, then the first onshore intermediary is your company (hence the Intermediaries Legislation) and it will be your responsibility to determine the status of an engagement (and have the liability for an incorrect decision).

If an overseas client has a UK presence, then they will have the decision-making responsibility unless part of a group which is a small company – logically the group would need to be considered, not the size of the UK presence.

Finally, the fact that the work may be overseas does not mean that IR35 does not apply.  If your company is based in the UK, then it is subject to UK tax law.

Where the exemptions do not apply

All other engagements with PSCs which commence on or continue beyond 6th April 2021, will require end clients to consider whether IR35 applies and create a Status Determination Statement (SDS). This will also be required where a current engagement extends beyond the tax year: until April 5th 2021, contractors in the private sector have the responsibility to determine the IR35 status of their engagements; from next tax year, responsibility (and liability) transfer to other parties where the contractor is engaged by a medium or large sized end client.

Where an end client genuinely outsources a project or complete service – e.g. IT, HR, facilities management, security, catering etc – to a 3rd party, then that 3rd party becomes the end client for the purposes of IR35.  If they engage contractors, they will have all the responsibilities of an end client in respect of the Off Payroll legislation, and these are set out below.

If, however, the end client is using the consultancy to fill “vacancies”; i.e. to find a project manager, a business analyst, a tester, etc, then the consultancy would NOT be the end client for the purposes of the legislation, but would be taking on the role of fee payer because it will be paying the freelancer’s company.  In this scenario of filling roles, the end client is the decision-maker and must create the SDS.

The SDS must be issued to the individual worker and where there are recruitment agencies in the chain, then it is the end client’s duty to also pass on the SDS to the agency immediately below it in the chain; and where there is more than one agency in the contractual chain it is the responsibility of Agency One to pass it on to Agency Two and so on.

A Status Determination Statement MUST be issued by the end client, irrespective of whether the engagement is inside or outside IR35.  Failure by the end client to issue an SDS to the relevant parties would result in the end client having the status of fee payer and HMRC collecting the tax due from the end client – even if the correct tax has been deducted by the entity lower in the contractual chain which was responsible for paying the PSC.

Similarly, failure of an agency to pass the SDS on to the next agency in the contractual chain would mean that agency had failed in its responsibility and it would have the fee payer liability.

Umbrella companies and IR35

Umbrellas can be engaged by end clients, but typically they sit in the contractual chain below a recruitment agency. Umbrellas have always fulfilled two main functions: a means of paying contractors where an agency did not want to set up their own PAYE department to pay workers; and often the vehicle used by freelancers who wanted to take a first step into contracting, but didn’t want to go straight into setting up their own company.

Umbrella company workers are all employees of the umbrella and paid under PAYE.  The umbrella will take a margin from the fee paid by the agency with the balance paid to the worker after statutory deductions such as Employers NICs, apprenticeship levy, pension deductions.  The Umbrella is the individual’s employer and the individual accrues the same employment rights as you would in a permanent job.

As many engagements are linked via an agency to a particular umbrella or choice of umbrellas, the workforce in an umbrella is usually quite transient and it would not be a surprise to find yourself working through a number of umbrellas in any one tax year.

What is the position on indemnity clauses appearing in agency contracts with PSCs?

This is a legal question rather than a tax matter, and the answer whether such clauses are enforceable may require parties going to court for a judgement – but they are increasingly more common.  As a limited company is deemed to be a sophisticated entity, then the issue of ‘duress’ which was raised by one attendee may not materialise, although a judge might wish to consider the bargaining power of the two parties.  There is also the question whether national Insurance liabilities can be passed on – many would argue that is not the case.  Finally, does an agency want to have the reputation of suing its candidates?  Probably better for the agency to look to insure its fee payer liabilities – something Markel Tax can assist with.

Can I offset liability insurances against my personal tax?

If you are trading as a sole trader, then you can claim liability insurance as a legitimate business expense which would reduce your profits and therefore your tax bill. Technically, under the expenses legislation, professional indemnity can be claimed against your personal tax liability if it is for the provision of your duties – an argument would be that end clients/agencies require it – but the rules are stringent – please follow this link to HMRC’s Employment Income Manual: EIM31630

HMRC would probably expect some form of apportionment between the cost to your company and you personally. Regrettably I couldn’t find anything specific relating to claiming liability insurances and HMRC’s guidance in this area is not clear.

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