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Off-payroll tax rules: What are they and why do they matter?
- 20 Mar 2019
In an ideal world, the off-payroll tax rules, or IR35 as it is commonly referred to, would cease to exist, or, perhaps more sensibly, would have never been created in the first place. Sadly, IR35 is here to stay (for the foreseeable future at least) and independent professionals need to be aware of it.
Complying with IR35 is anything but straightforward. One of the most frustrating traits of this legislation is that many independent professionals have no idea whether it applies to their engagements, or not.
The good news is the government intends to remove the burden of determining IR35 status from the contractors. The bad news is that, from April 2021 in the private sector, the burden is going to pass to your client, and the decisions they make will affect your tax position. You won’t have any say in the process and the likelihood is that, in many cases, the clients will get it wrong.
This may sound bleak; however, it is unfortunately the reality of the situation. IPSE, The Association of Independent Professionals and the Self-Employed, is campaigning to prevent this dystopian near-future. In the meantime, it is important that all freelancers, particularly those that are new to it, understand what IR35 is and how it is set to change.
What is IR35?
IR35 is a tax law that allows HMRC to treat fees paid to a limited company as if they were an employee salary. It was created to stop ‘disguised employment’ – where individuals work through their own company, sometimes referred to as an intermediary, but act like an employee of their client.
Such arrangements can result in individuals paying less tax and remove the need for employers to pay National Insurance Contributions, as well as benefits (like sick pay and holiday pay) to their staff.
Why does everyone hate it?
The main problem with IR35 is that it unfairly affects the smallest companies: freelancers. Numerous freelancers who legitimately use a limited company model to supply services have been falsely accused of ‘disguised employment’.
Worse, IR35 investigations can be long, intrusive and extremely costly for freelancers. They can even cause reputational damage, and many freelancers expend large amounts of time and money protecting themselves from the risk of IR35 investigation.
IR35 remains on the statute book. That means everyone who provides services through their own limited company has to make sure they’re compliant with IR35 – or as compliant as it’s possible to be with such a complicated piece of legislation.
How is IR35 status determined?
IR35 status is largely dependent on three factors, so it is important to make sure your contract (and conduct while undertaking the contract) contains the following:
- An unfettered right of substitution. This means that the contractor is not contracted personally to do the work but could send a substitute in case of absence and shows that the relationship is not typically one of employment. The ‘unfettered’ aspect is important here – the contractor business shouldn’t need to ask permission from the client before sending the substitute.
- Direction, supervision and control. A genuine contractor should decide how to get the work done, not the client, so autonomy and independence in the relationship are vital.
- There should be no Mutuality of Obligation (MOO) in the relationship. MOO is a very a difficult concept to explain, and there is disagreement even among experts over what it means. The contractor is under no obligation to do work outside of what is stated in the contract, unlike a traditional employee, and the client is not obliged to provide additional work.
Technically, for IR35 to apply, the engagement must fall down on all three of the above, though it’s best practice to ensure that all three are addressed from the start. In addition to these, other factors such as using the client’s equipment or attending team meetings could come into play in the case of an investigation.
These factors could be used to evidence that the relationship is more one of employment than business to business.
It’s important to look beyond the contract to the actual working practices. It should be clear to all parties that the contractor is an independent service provider, not a member of the team.
Just because your contract looks IR35-proof doesn’t mean HMRC will not attempt to apply IR35.
What were the recent changes in the public sector?
Since April 2017, responsibility for determining whether a contractor falls under IR35 has been moved away from the contractor themselves to the public sector body they are working for.
If the public sector client decides IR35 should apply – and most have – then the contractor’s payments are taxed at source, as if they were an employee. Because IR35 is so complex, public sector bodies have no idea whether it should apply to their engagements or not. These organisations are naturally risk-averse, so inevitably, they applied IR35 across the board.
This overly cautious approach from public sector bodies has resulted in thousands of contractors paying more in tax than they should. In turn, this has led to many contractors moving out of the public sector and stalling numerous government projects.
The public sector change has been nothing short of a disaster and IPSE are doing everything possible to stop the government extending the changes to the private sector.
When are the IR35 changes coming into the private sector?
In the 2018 Budget, the chancellor announced that the public sector changes would be extended to the private sector from April 2020. While this was delayed by one year due to the coronavirus crisis, the changes are still set to go ahead from April 2021.Despite providing very little evidence to support its claims, the consultation document asserts that there is widespread non-compliance with IR35, and thus justifies the intention to extend the changes.
IPSE is working with clients and agencies to ensure they are well informed about their responsibilities. Clients do not have to put everyone inside IR35 – in fact, they are required to take ‘reasonable care’ when making determinations.
We have produced an explainer on what you need to know about the operation of IR35 rules in the private sector from next year, which you can read here. IPSE are continuing to campaign against this unfair tax legislation but in the meantime we are here to help freelancers and contractors navigate the new rules - you can get support, protection and representation for your business by joining us today.
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