What is IR35

What is IR35 and what does 'inside IR35' mean

What is IR35?

  • Also known as the “intermediaries legislation”, IR35 is intended to stop “disguised employment”. This is where employers engage their employees through limited companies, thus avoiding the need to pay Employer’s National Insurance Contributions, Sick Pay, and Holiday Pay, with the disguised employee also potentially able to benefit from a reduced tax bill. It has been in place since 2000.
  • IR35 taxes the fees paid to limited companies in a manner similar to a salary where HMRC believes an engagement falls 'inside IR35'.

What does it mean to be 'inside IR35'?

  • Being ‘inside IR35’ means that the freelancer is seen as an employee by HMRC.
  • For IR35 to apply, HMRC has to determine whether the relationship between a freelancer and their client is in fact an employer-employee relationship, by referring to a number of complex and subjective tests established in case law. More information on these tests can be found on here.
  • These tests are unclear, making it impossible for freelancers to determine with any certainty whether they fall inside IR35.
  • Freelancers working through limited companies are often engaged by businesses because of the flexibility and skills they provide. The legislation creates risk and uncertainty for such individuals and it ignores the fact they are genuine businesses, not disguised employees.
Changes to IR35

Understanding the changes to IR35 in the private sector

Following the 2019 General Election, HM Treasury confirmed that reforms to the way IR35 works in the private sector would go ahead. Due to the COVID-19 pandemic and subsequent lockdown, its implementation was delayed.

Since April 2021, IR35 status must be determined by the client not the contractor. If the client decides that the engagement falls in the scope of IR35, payment to the contractor's company will be taxed at source - as if they were an employee.

IPSE strongly opposed this change. We believe it has forced thousands of compliant contractors out of business, reduce labour market flexibility and ultimately damaged the UK economy. We put these arguments directly to the Chancellor, the Financial Secretary and senior officials, and have submitted comprehensive responses to the various consultations. We have held and attended numerous roundtables and events, and commissioned surveys and independent research.

We remain committed to our lobbying efforts and will continue to make the case for this ill-thought through policy to be reconsidered – and that what is needed instead is a wholesale review and reform of self-employed taxation that would make IR35 redundant. However, as things stand these changes are in effect and it is vital contractors understand them.

Become an IPSE member to support our campaign work

 

How is IR35 changing?

The underlying IR35 rules haven’t changed, but the responsibility for determining whether they apply has shifted from the contractor to the end client.

The client (sometimes referred to as the hiring organisation) will determine the IR35 status of an engagement and must provide the contractor with a Status Determination Statement (SDS). The SDS will inform the contractor of the status decision and the reasons behind it. The SDS will also be passed down the supply chain i.e. to the agency (if there is one).

If the client decides IR35 applies, the contractor business will be taxed at source, through the Real Time Information (RTI) system, exactly like an employee. The tax will be deducted by the ‘fee payer’ – which is whoever it is that pays the contractor’s company. If you contract directly with the client, the client is the fee-payer. If your contract is with an agency, it’s the agency. It is also likely a payroll, or umbrella, company will enter the supply chain as the fee-payer, if the engagement has been deemed ‘inside IR35’.

Although contractors caught by this measure will have to pay tax like an employee, their employment status will not automatically change, so they will not necessarily receive the rights and benefits that go with employment such as pension contributions, holiday pay and unfair dismissal rights.

These changes bring IR35 in the private sector into line with how it works in the public sector (where the rules changed in 2017). There are some new tweaks, notably the small company exemption. 

Exemptions

What is the IR35 small company exemption?

The changes to IR35 do not apply where the end-client is ‘small’. To qualify as small company, the client must meet at least two of the following three criteria:

  • No more than 50 employees
  • No more than £10.2m turnover
  • No more than £5.1m on the balance sheet

If the end-client is small, the contractor retains the responsibility to make the IR35 assessment, and the tax liability if they get it wrong – just as they have for the last twenty-one years.

The IR35 small company exemption only applies in the private sector. It may be more accurate to call it the small client exemption as it only applies where the end-client is small. It does not apply if the agency or contractor’s limited company is small.

Accurate Determination

Will clients be able to make an accurate IR35 determination?

What Is The HMRC IR35 Small Company Exemption
 

Will clients be able to make an accurate IR35 determination?

This is IPSE’s primary concern. We fear that because the IR35 rules are so complex, clients will not be able to tell for certain whether an engagement is caught inside IR35. Clients could become liable if they make the wrong determination, so they are more likely to take a risk averse approach and decide to apply IR35 if there is any doubt whatsoever (and there is usually an element of doubt when it comes to IR35).

We have already seen some clients – most of the major banks and a few other large companies too – publicly announce they will no longer hire limited company contractors at all. They fear getting determinations wrong, so they have decided not to hire anyone that would require them to provide an SDS.

This is a highly worrying trend and it makes a mockery of the government’s claim the legislation won’t impact the genuinely self-employed. Very clearly, genuinely self-employed people have been impacted. Their clients refuse to do business with them because of the compliance risk created by this legislation – we have made this point to the government.

Some clients are issuing ‘inside IR35’ determinations on all their engagements, regardless of the actual IR35 status. This is sometimes referred to as a ‘blanket determination’ or ‘blanket assessment’. Clients should not do this. The legislation requires them to take ‘reasonable care’ when determining status – blanket assessments fail the ‘reasonable care’ provision.

If your client hasn’t yet spoken to you about IR35, you may want to consider approaching them. You should explain why the engagement doesn’t fall within IR35 and provide evidence to back that up. That could be a contract review or even a CEST result (see more on CEST below). You could set out in writing the true nature of the engagement, noting all the reasons why your engagement could not, and should not, be misconstrued as a disguised employment.

If you suspect your client is blissfully unaware of its IR35 obligations, and is likely to remain so, it may be in your best interests to stay quiet. After all it will be your client, not you, who will be held liable for its lack of action. But sooner or later the client will wake up to IR35, and may well be tempted to take a very risk-averse approach. If you have a good relationship with your client, it is better to lead them (where possible) and try to help them come to the correct IR35 determination.

What is CEST?

In a bid to assist clients to make determinations the government has published the Check Employment Status for Tax (CEST) tool. CEST asks a series of questions and generates a status decision based on the answers provided. IPSE believes CEST is fatally flawed and will frequently lead to inaccurate IR35 determinations.

While CEST primarily exists for clients, it can be used by anyone, including contractors. It’s entirely anonymous – you don’t have to put your name or company name into it, and HMRC keep no record of it. If you use it and it provides you with a result which says ‘IR35 does not apply’, keep it and share it with your client – it may help them get the SDS right. The CEST tool can be found here.

Appeals

Can contractors appeal against the client’s decision if they don’t agree with it?

Yes, but don’t get too excited. Contractors have the right to challenge the SDS, if they disagree with it. The client then has 45 days in which to respond. But there is nothing to compel the client to change its mind and the contractor has no access to the courts or other independent arbitration service. We believe clients are unlikely to change their mind on a status decision, and so the dispute procedure, in most cases, will not result in the SDS being corrected.

Nevertheless, if you feel your client has got the SDS wrong, it is worth a challenge. You should provide evidence which demonstrates the engagement sits outside IR35. This could be a contract review, or even your own CEST results, assuming they determined the engagement was ‘outside IR35’.

Will HMRC retrospectively investigate engagements that have now been determined to be inside IR35?

This question has come up a lot. Contractors are understandably worried that if their client decides that IR35 should apply, HMRC might be more likely to look at the months preceding April and ask "shouldn’t IR35 have been applied to income received before then too?"

The government has been somewhat helpful here and issued assurance that HMRC will not use the new SDS to open an investigation into previous years, unless it suspects fraud or criminal behaviour. That statement of assurance can be found in the penultimate paragraph of Section 2 of this guidance.

However, there is nothing in the legislation which prevents HMRC from breaking its promise. Contractors considering remaining in an engagement, even after the client has issued an ‘inside’ SDS, should therefore consider taking steps that might help to draw a clear line between the pre-April ‘outside IR35’ contract, and the post-April ‘inside’ one. At the very least you should get a new contract in place. You may also consider the more nuclear option of terminating your engagement with that client altogether and finding work elsewhere.

At the end of the day, HMRC retain the ability to launch an investigation into the last six years, when you – not your client – had the liability. IPSE membership will continue to provide IR35 investigation insurance, even after the change to the rules this April.

Become a member

 

What about employment rights?

In January 2020 the government issued a fact sheet which sought to clarify the position on rights:

“Where the rules apply, it is important to note that, unless you have a direct employment contract, you will not be classed as a direct employee of the hiring organisation you provide your services to. This means that you will not be entitled to statutory payments or employment rights from them.”

IPSE is not convinced the legal position on employment rights is quite so straightforward. We also feel there is an ethical question about whether it is right for a client to decide a role is very close to an employment (for IR35 purposes) but then not be obliged to employ that person.

In 2018, IPSE supported one of its members, Susan Winchester, in her claim for holiday pay against her client, HMRC, after the public sector rules were introduced. The case was settled for the full amount just before a tribunal was due to take place. You can read more about this case here.

But this area of the law is far from clear. Every case has its own permutations and complex supply chains make matters even more difficult. The default position, therefore, is that employment rights do not automatically flow from an ‘inside IR35’ determination. But if you were minded to challenge that, it is possible a tribunal would be sympathetic, depending on the individual circumstances.

How much worse off are individuals likely to be?

This is very difficult to say. It depends on your circumstances and the structure of your company. If you are currently claiming tax relief on travel and subsistence expenses, then that will be stopped so depending on the value of that relief, the impact could be significant. In addition, the direct tax impact will be greater if you currently take the maximum in dividends than if you pay yourself a significant salary. You may have a spouse as a company director; you may leave money in your company to invest at a later date; you may get involved in tax planning.

If IR35 is deemed to apply to an engagement then all income from that engagement will be taxed as employment income. This will largely shut down the options listed above. It will probably make some engagements unviable, particularly those which involve high travel and subsistence expenses. A lot will also depend on who ultimately picks up the bill for the Employers’ National Insurance Contributions (see below).

'Outside IR35' tax calculation compared to an 'inside IR35' tax calculation

Even if you make use of none of the above options, the tax you pay will increase if IR35 is applied. Below is an example which compares a very straightforward ‘outside IR35’ tax calculation, to an ‘inside IR35’ calculation.*

Jill’s limited company charges £500 p/day and works for 42 weeks in the year. Her turnover is £105,000. IR35 does not apply to any of the income, so Jill’s company must account for the tax itself.

Jill pays herself a salary of £8,632 (the primary threshold for National Insurance). After corporation tax and dividend tax have been taken into account, Jill is left with £72,597.

If Jill’s client had decided IR35 applies, the fees would have been taxed at source. After income tax (PAYE), employee’s NIC and personal allowances had been accounted for, Jill would have been left with £68,433. Jill’s client (assuming they are the fee payer) would also have to pay the Employers’ National Insurance Contributions which are £13,300.

So, Jill is worse off by £4,164 if IR35 is deemed to apply. Her client is worse off by £13,300.

The client may try to pass down the employers’ NI cost by cutting the fees paid to Jill by £11,686. This would neutralise the IR35 cost for the client – they are still paying £105,000 over the year for Jill’s services.

Because of the cut in her fees, Jill is now on a day rate of £444. Her annual take home pay is £57,579. She is £15,018 worse off because the client applied IR35, and adjusted her rate to cover their NI costs.

These calculations are illustrated in the tables in the appendix, along with other day rate examples.

*Calculations are based on 2019/2020 tax rates and allowances. All figures are estimates and may vary depending on specific circumstances.

National Insurance

Who pays the employer's National Insurance?

The fee payer must pay the Employers’ National Insurance (NI), but they may try to charge it back to the contractor through a cut in rates. The client or agency (whoever is the fee payer) will pay Employers’ NI, should it be determined that IR35 applies to the engagement. If your company is paid by the client, the client will pay it; if an agency pays your company, they will pay it.

What the employer pays

Employers’ NI is 13.8% on top of whatever is paid to the employee, or in this case the ‘deemed employee’. Neither clients nor agencies want to bear that cost. In the public sector, where these rules have been in place since 2017, we have seen many examples of the fee payer cutting the contractor’s day rate to make up the cost of the Employers’ NI. In other words, the contractor bears the cost, through a cut in rates.

Some fee payers may also become liable to pay the Apprenticeship Levy (typically 0.5%) and this too has been charged back to contractors in the public sector.

It is up to you whether you are prepared to accept such a cut. In some instances, this will be presented as a ‘take it or leave it’ option, but if the client wants to keep you on the project, there should be scope for negotiation.

We are aware of examples from the public sector where the contractor has managed to negotiate an uplift in rates in order to ensure their take home pay is unaffected by the IR35 determination.

IR35 Employers NI (National Insurance) – Who Pays It

 

Umbrella

What role do umbrella companies play in this?

It will often be the case that the fee-payers will not want the contractor on their own payroll, even though the client has determined IR35 applies. Instead they will turn to an umbrella company (or ask you to find one) which will make the tax deductions and give the net pay to you. Many umbrellas will ‘employ’ you directly, taking your limited company out of the picture. You will be entitled to receive holiday pay, but it will be ‘reversed-out’ of your total pay – in other words it won’t be provided on top of your agreed rate, rather a proportion of your agreed rate will be your holiday pay. Take care to ensure you understand your holiday pay entitlement and that you receive it. You may have to ‘claim’ your holiday pay and do so within the calendar year to which it applies. There have recently been disputes over holiday pay and suggestions of sharp practice by umbrella companies to be careful.

Umbrella companies are not well regulated in the UK at present. While some are entirely compliant, there are others who are not. You may find umbrella companies that offer elaborate schemes with very attractive take home rates. IPSE advises extreme caution when considering these companies. It is highly likely HMRC will take the view that they are using disguised remuneration schemes, which could leave you with a huge tax bill in years to come. Many of those who are suffering from the effects of the Loan Charge entered into schemes such as these through unscrupulous umbrella companies. If you find yourself having to work through an umbrella, go with one that has a good reputation.

IPSE has told the government it should urgently regulate umbrella companies. We continue to make this point.

What are the alternative options?

What happens where there is a contracted-out service being provided to the client?

If the client is receiving a contracted-out service, it does not have to consider the IR35 status of any limited company contractors which are providing that service. That responsibility falls to the service provider.

To use an example, imagine a large pharmaceutical company that wishes to procure cleaning services for its offices. It goes to a cleaning company to provide that service. The pharma company would not need to consider the IR35 status of the cleaners, even if they were operating through their limited companies. The cleaning company, however, would have to consider their status, unless it was a small company, in which case the cleaners would retain the IR35 risk due to the small company exemption.

That is a straightforward example of a contracted-out service. But what if the pharma company went to a consultancy to provide IT support? HMRC might take the view that the consultancy was supplying labour, not services, in which case it would expect the pharma company to make IR35 determinations on its engagements with those individuals.

The rules around what is and what isn’t a contracted-out service are not clear. Indeed, trying to work out what is and isn’t a contracted-out service is probably just as hard as working out IR35 status. There is likely to be a great deal of confusion, disputes and maybe even court cases over this point. IPSE has asked HMRC to publish guidance and several worked examples to try and provide more clarity in this area.

Technically, there is nothing to stop a contractor’s limited company offering a contracted-out service to its clients. If it could be established that it genuinely was a contracted-out service, the IR35 determination responsibility would rest with the contractor’s limited company, not the client – even if that client was medium or large (i.e. the small client exemption didn’t apply). But HMRC are likely to be highly suspicious of such arrangements and will want to look closely at them. If HMRC did not believe it was a contracted-out service, they would go after the client for failing to provide an SDS.

What happens if a group of contractors band together to form a consultancy?

This question has been raised often. The thinking is that a small group of contractors could form a consultancy, through which they could provide their services on a ‘contracted-out’ basis. The IR35 liability would therefore shift away from the client to the consultancy - or contracted-out service provider. But because the consultancy would meet the small client exemption, the liability would actually fall to the individual contractors, as it always has.

Because this model would effectively undo the new IR35 rules, HMRC are likely to be instinctively wary. Were such an arrangement to be investigated, the question would be whether the consultancy was really supplying a contracted-out service or whether it was supplying labour (see above). Ultimately it would be the client that would be ‘on-the-hook’ if HMRC took the view that this was really just the supply of labour.

Are Statement of Work contracts a way to ensure an engagement is outside IR35?

A Statement of Work (SoW) is an agreement which clearly define the work that must be done. It will usually include agreed milestones, often within specific timeframes, and frequently will stipulate that payments are made on the achievement of those milestones – though this is not absolutely necessary.

Because SoWs clearly define the project and make it clear the contractor has tightly defined deliverables, IPSE believes they can play a role in demonstrating IR35 does not apply. They could even be used to demonstrate the contractor is in fact offering a contracted-out service (see above). But the working practices must mirror the contract. It has to be ‘real’. An SoW will be of no help at all if the engagement is really a disguised employment.

Summary

In summary

IR35 has always been a huge burden on contractors. These changes have made it worse. Clients and agencies, which had never had to grapple with these arcane rules before, have now been thrust into the labyrinthine world of status determination. They frequently get it wrong, often to the detriment of the contractors they hire. Others are so afraid of IR35, they have stopped hiring contractors altogether - turning their backs on the contractor model that has served them so well over many years.

For these reasons and more, IPSE is still deeply opposed to the changes to IR35 and working to highlight the damage they are doing.

For a long time, it has been clear that IR35 is a patch-up for a tax system that simply isn’t built with the self-employed in mind. Now, our long-term aim is to drive a wholesale review and reform of self-employment and the tax system in the UK to make it work for employees and the self-employed alike. We need a simpler and fairer system – one that removes the need for IR35. That is our core campaigning focus now.

For now, there are a few steps – which have been discussed throughout this document – that may help contractors with these changes, which are summarised in the checklist below:

 

If you intend to remain in your current engagement, get your contract and working practices independently reviewed now. IPSE has a review service. Members get a discount
Consider approaching your client on IR35 (if they haven’t spoken to you already). Explain why IR35 doesn’t apply. Show them the results of the contract and working practices reviews (if they determine IR35 doesn’t apply)
Complete the CEST tool. IPSE doesn’t like the tool, but it might determine IR35 doesn’t apply, in which case show the result to your client. (If CEST doesn’t put you outside IR35, don’t worry – its anonymous and you don’t have to share it with anyone)
If you disagree with your client’s determination you can dispute it. Again, show them any evidence you have that IR35 doesn’t apply. To be honest, it is likely they will stick to their determination, but it may be worth a shot – you have nothing to lose
An inside IR35 determination may provide an opportunity to negotiate an increase in your day rate. If your client wants to keep you on the project, they may be prepared to ease the tax burden by paying you more
For future engagements, think about how you present your business. The more you can demonstrate that you are in business-on-own-account, the more confident the client will feel about determining the engagement sits outside IR35
Remember the new rules do not apply where the client is ‘small’, so if you want to avoid these difficult discussions with your clients altogether, and if it’s feasible (which it isn’t for many contractors) find small clients to work with
Statement of Work contracts can be helpful but the engagement must be structured around the genuine delivery of a project. Being paid on the achievement of milestones is helpful, but not essential
Contracted-out services, possibly combined with Statement of Work contracts, might form part of a solution to this, but it’s really up to the client whether they accept these models
If you work via an umbrella company be very, very wary of eye-catching take home rates. It is probably a non-compliant umbrella and you could end up with a huge bill to pay at the end of it
Remember, although clients and agencies will have the IR35 liability from April 2021, you are still liable for the last six years. Your IPSE membership protects you from the risk of investigation over that period, provided you retain it.
 
Calculations

See how IR35 will affect you: 'Outside IR35' calculations compared to 'inside IR35' calculations

Calculations are based on 2019/2020 tax rates and allowances. All figures are estimates and may vary depending on specific circumstances

Day rate £300

Inside / outside IR35 – difference in take home pay

 

Day rate £500

If the contractor charged £500p/day and worked for 210 days, the calculations would be as follows 

 

Day rate £900

If the contractor charged £900p/day and worked for 210 days, the calculations would be as follows

 

FAQs

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.

 

IR35 Q and A webinar

IR35 Q and A webinar 

One of the key problems with IR35 is that the legislation is notoriously complex. In this guide, Paul Mason, Head of Tax at our partner Markel, unpicks this complexity and answers some of the most common questions about the rules.

To view this webinar, login or become an IPSE member.

 

 

 

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