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Intermediaries Legislation, or more commonly known as IR35, is made to tackle tax avoidance, specifically targeting individuals of which are providing their own services through their own limited companies or partnerships and who may not be paying tax when they should be.
Contractors need to be aware of the consequences IR35 can lead to.
The outlook on IR35 is a simple one to follow; if you are treated like an employee, you should be taxed like one. There are areas of the legislation that aren’t transparent and points which may not seem of concern to many but can have huge impact. It is always best to consult an expert before determining your position on IR35.
If you are to work ‘outside’ IR35, you risk being on the receiving end of an IR35 enquiry. The enquiry is effectively an investigation where HMRC will review your circumstances and decide whether you have been paying tax correctly or not. If you are deemed not to have paid your taxes correctly, you will pay back all the tax and national insurance that you should have paid if you were an employee, as well as potentially paying added interest and a penalty fee. This can quickly add up to thousands of pounds, hence why IR35 is a significant issue for contractors.
During the enquiry, HMRC will look at your contract you have with either your client or agency and will delve into the actual working practices you have between your client. If HMRC determine your contract is IR35 compliant but discover you are treated like an employee, the outlined contract is effectively worthless. It is essential that your working practices and contract mirror each other.
IR35 bases its outcomes on historic court law and previous court rulings (the tests below are key, however there are many more factors).
Dubbed the most important test when facing IR35, Personal Service/Right of Substitution investigates that businesses should not have to provide the contracted services personally, and should have ‘the power of unlimited delegation’. This essentially means that contracts should not be compiled merely on you supplying the work personally. Businesses should be entitled to provide a substitute worker to complete all or some of the work you as a business have secured. Your business would maintain responsibility for the contract, substitute worker and their payment.
This test is to show that the client is in full control of how the services are completed by the candidate. A basic and good example is of a plumber or electrician. You require their services at your home, you don’t tell them how to do their job, hence why you assisted their services in the first place. In the case of a written contract, but for more so your working practices, you need to agree with the client that you are in full control of how you complete your services.
This test is that of an expected source of work, so as a business they shouldn’t expect workers to carry out further work and the client should not be expected to provide it. The business stating a clear start and end date in each contract it produces is critical, because without the clear timescale of your engaged state, the Revenue may take the view that there is a presumed continuation of the contract.
IR35 was first issued in 2000, targeting workers HMRC considered to be ‘disguised employees’. Contractors, being technically self-employed, are not taxed in the same way as your normal employees, taking dividends from their company and paying far less in National Insurance Contributions. HMRC are eager to ensure that those working as contractors (and paying less tax) are indeed genuinely in business on their own account and are not working in the same way they would have been if employed directly by their client.
From 6th April 2017, the responsibility for determining the IR35 status of a contract shifted from the contractor to the public sector client. This impacted all contracts where payments were made after this date.
If a contract is considered inside (caught) by IR35, the party paying the worker’s company – which will normally be an agency - will have to deduct PAYE and NI before making payment to the PSC.
The agency effectively becomes the employer of the contractor for tax purposes only. The contractor will be left with the net payment to their PSC, for which tax credits will apply to avoid double taxation.
It is important to remember that those considered outside IR35 will be able to continue as normal, extracting funds from their PSC as they see fit. The only change will be that the IR35 ‘risk’ will lie with the agency.
It was announced in the 2018 Autumn Budget, that the public sector rules would be extended to the private sector from 6th April 2020:
“The government has carefully considered all of the responses received and we are now in a position to propose extending rules similar to the April 2017 public sector off-payroll working reform to the private sector. Having listened to concerns, the changes for the private sector will be introduced from April 2020 for medium-sized and large businesses only.”
This means that medium and large client businesses will be responsible for determining the IR35 status of their contractors, and the agency or end client will be responsible as the ‘fee-payer’ for deducting the relevant tax and NIC; small businesses will be able to continue as they currently do, owing to several concerns during the consultation that there would be administrative burdens for smaller businesses to follow through with making the necessary changes.
Those workers who fall inside of IR35 will have PAYE and National Insurance Contributions (NICs) deducted at source from their income.
A further consultation to ‘refine the design of the reform’ was released on 5th March 2019 looking to address issues with the reform up to and informing the draft Finance Bill, expected to take place in Summer 2019. The consultation included provisions for the transfer of liability should a party fail to comply with their obligations, suggestion for a client-led disagreement process to manage status disputes, as well as the requirement for sharing of information – affording contractors with greater visibility over the determinations being made for them.
Taking steps to understand the contractor workforce from an IR35 perspective is imperative to help you build a process for managing the reform when it comes into effect in 2020.