IR35 and the Off Payroll Legislation
Contractors who work through their own limited companies enjoy a level of tax efficiency afforded for being in business in their own right. While they don’t get employee benefits (like holiday and sick pay), they have flexibility and control over their work. These factors, combined with the tax efficiencies, make this model very attractive to individuals working in the labour supply market.HMRC has for some time been targeting these arrangements because it doesn’t believe it’s appropriate to afford corporate tax efficiencies unless the worker can be proved to be genuinely self-employed.
HMRC introduced the Intermediaries Legislation 2000 in a bid to tackle what it calls ‘disguised’ employment.
HMRC believes that some contractors (and their hirers) might try to take advantage of the tax efficiency of working through a limited company when in practice the contractor is essentially working as an employee.
The benefit for employers hiring workers in this way is that they don’t have to pay employers’ National Insurance contributions or give contractors employee benefits. The benefit for contractors is tax efficiency.
Using a certain number of principles, IR35 assesses whether contractors are for all intents and purposes employees when they take on work for clients. If found to be ‘inside IR35,’ HMRC deems a worker to be an employee; save for a 5% allowance for business expenses (private sector only), all other income is considered employment income and must be taxed accordingly (Employer’s NI & Employee’s NI and PAYE). The public sector rules have removed the 5% allowance for expenses.
The legislation is widely considered to be complicated and difficult to understand. Even HMRC itself seems to struggle - of the 6 cases it has brought to tribunal since April 2017, it has lost five.
IR35 rules for limited companies
When does IR35 apply?
HMRC says that when determining whether IR35 applies to a contract or engagement, “you must work out the employment status of the person providing their services.”
HMRC goes on to say that the off-payroll rules apply if the contractor “would be an employee if there was no intermediary”. The intermediary in most cases is the contractor’s limited company (often called a personal service company, or PSC).
Amongst any number of other factors, IR35 centres around 3 key principles:
Right of Substitution; is the Contractor bound to personally provide his services? Or does the contract allow for the company to deliver services to the client regardless of who specifically provides them?
Mutuality of Obligation (MoO); is there an obligation on the client to provide consistent and paid work, along with an obligation on the part of the worker to personally carry out the work?
Supervision, Direction or Control (SDC); does the Contractor have control over how he does the work? A very significant factor when determining IR35 status is whether the client dictates (or has the right to dictate) what, when and where the work is carried out. If it does, this can be a strong indicator of employment. This should not be considered an immediate fail, however, since it must be looked at within the picture as a whole.
In reality, IR35 status hinges on case law and employment legislation, itself reliant on decades worth of employment tests heard in the UK courts.
To assist with making status determinations, HMRC has developed CEST (check employment status tool), but this tool is widely considered to return inaccurate results due to its simplistic design and lack of any consideration on Mutuality of Obligation. Returned results are considered to capture many more assignments as being in scope than ought to be appropriate.
Off Payroll Legislation (Public Sector 2017, Private Sector 2020)
Whilst the main principles of IR35 remain the same, this latest off payroll legislation seeks in the main to address the key area that HMRC feels has been responsible for its perceived non-compliance of IR35 – by moving the responsibility for making IR35 determinations away from the PSCs themselves, up to the end hirers, i.e. the ultimate entities into which the PSCs are providing services.
There are currently different rules for public sector and private sector contracts.
for public sector contracts – the hirer is responsible for working out whether the contractor falls inside or outside of IR35. If they fall inside, the hirer, agency or other third party who pays the contractor then needs to deduct tax and NICs and report them to HMRC
for private sector contracts – the contractor is responsible for working out whether they fall inside or outside of IR35. If they’re inside, they need to pay the tax and NICs due
The private sector IR35 reform is set for April 2020, when, subject to certain amendments, the public sector rules will extend to private organisations - and any changes made will cover both sectors. There will be an exemption for small businesses, expected to follow the Companies Act 2006 definition.
These changes mean that many private sector engagers who hire contractors will soon be responsible for determining the IR35 status of those contractors. Both businesses and contractors should start preparing for this change as soon as possible. Information on its current form in the public sector can be found here: https://www.gov.uk/guidance/off-payroll-working-in-the-public-sector-reform-of-intermediaries-legislation
The Summary of Responses to the recently closed consultation indicate that we can expect some relatively minor changes, alongside the small business exemption: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/817442/Off-payroll_working_rules_from_April_2020_summary_of_responses.pdf
What we now know is that by April 6th 2020, all hiring businesses except those with a small business exemption will be expected
to have educated internal workforces in the principles of IR35 in order that they can apply these under the associated Off Payroll rules
to have assessed existing contingent labour supplies and effectively communicated all relevant determinations throughout supply chains.
to have put in place practices and processes to allow ongoing determinations and communications as applicable to all new engagements.
MPI recognises that these changes are likely to represent different challenges across our varied client base, and we fully intend to offer our support both during the transition and on an ongoing basis.
Our strategies for doing so include
Securing an insurance-backed tool that clients wishing to manage determinations in-house can acquire and use to assess all their contingent labour requirements
Providing access to an insurance-backed tool to assist in making determinations for those clients not wishing to procure or develop their own tool
Holding client workshops to inform and to discuss appropriate approaches
Arranging an online forum for Contractors, which will be monitored to enable us to respond across a wide audience to any questions and concerns raised
We will of course be communicating in the near future with both clients and contractors, but if in the meantime you have any concerns or simply wish to discuss the changes in more depth, please feel free to contact MPI’s Finance Director using the details provided below.
Sarah Grant MPI Finance Director
(t) 01992 517917