IR35, also known as ‘intermediary legislation’ was introduced in 2000 to tackle ‘disguised employment’ by employees masquerading as contractors in order to receive the tax advantages available.
This legislative measure was introduced by the government as organisations are able to reap the benefits of engaging self-employed workers. They can save large amounts of money, as by engaging a worker on a contract basis, the employer will not be required to pay Employer’s NICs or provide employment rights and benefits.
Let’s put it into perspective. If an employee leaves work on a Friday and returns back to work on Monday to carry out the same role as a contractor, saving them money on tax, this is when IR35 will come into play.
As a result of changing rules around IR35, HM Revenue & Customs have developed a Check Employment Status for Tax tool (CEST), previously known as the Employment Status Service (ESS).
The digital IR35 tool determines whether the legislation applies to a contract, whether the worker should pay tax through PAYE and whether off-payroll working rules should apply to a public-sector engagement.
If you fall foul of IR35 legislation, the financial ramifications can be significant, so it’s important to understand how it works. When undertaking an IR35 assessment, there are two classifications which can be determined:
If you are deemed to be inside of IR35, you will be taxed as if you are a PAYE employee, which means that you will be required to pay national insurance and income tax. By operating through an umbrella company such as Gorilla Payroll, your national insurance contributions and income tax will be automatically sent to HMRC before you are paid.
Each contract the company undertakes will have to be assessed as to whether it falls inside IR35 or outside IR35. You may find that within one year, you may have contracts which are inside and outside IR35.
It’s worth noting that it is not the company which is trading inside or outside of IR35, but it is each contract that the company undertakes.
If caught by IR35, it’s typically tax efficient to operate through an umbrella company, but this does not rule out working through a limited company as there are still advantages of working in this way.
This is the ideal scenario for a contractor operating through their own limited company. If your contract lies outside IR35, you will not pay national insurance contributions or income tax. As a result of your status, operating through a limited company may be the more tax efficient way of operating.
During the Autumn Budget 2016 announcement, the Chancellor of the Exchequer announced that the manner in which IR35 status will be determined for public-sector contracts will be facing a major reform.
The enforced changes now mean that when working on a public-sector contract, the public-sector body will be responsible for determining IR35 status, rather than the contractor.
Since this came into force, there has been speculation about rolling the change to the private sector. The certainty of this was confirmed following the Autumn Budget 2017when it was announced that a consultation would take place to determine the appropriate next move.
In addition to this, the 5% allowance has also been removed. If the contractor is caught by IR35, employment taxes will typically be withheld by the recruitment agency.
Since the reform came into play, the NHS has been accused of making blanket decisions by defaulting contractors inside IR35, in an attempt to clampdown on tax. This brings into question if reasonable care is being taken when employment status decisions are being made.
IR35 non-compliance cost the Exchequer around £440m within 2016 – 2017. As a result, the Treasury voiced hopes to bring 20,000 contractors within the remit of the IR35 reform legislation, with IT contractors making up a significant chunk of this number.
The public-sector changes came into play despite disagreements from the sector. The IR35 reform contributed towards mass walkouts after the tax status of contractors changed, with many waiting to leave after contract end dates. As a result of this, the completion date for many government projects faced massive delays, including the NHS.
HMRC introduced a service to find out if you, or a worker on a specific engagement, should be classed as employed or self-employed for tax purposes. The CEST toolgives HMRC’s view on whether:
The unprecedented IR35 reform in the public sector has been the subject of disagreement as the CEST tool has been responsible for delivering confusing results. Around 15% of CEST users have received inconclusive results on their employment tax status.
HMRC states that in order to use the CEST, the following information will be required:
The answers should reflect the usual working practices of the engagement.
Following the Autumn Budget 2017, the Chancellor announced that a consultation will take place to determine whether the IR35 reform should be rolled to the private sector. The consultation will take into account external research, and the full report is due to be published in 2018.
The Autumn Budget red book reads as follows, “The government reformed the off-payroll working rules (known as IR35) for engagements in the public sector in April 2017.
“Early indications are that public-sector compliance is increasing as a result, and therefore a possible next step would be to extend the reforms to the private sector, to ensure individuals who effectively work as employees are taxed as employees, even if they choose to structure their work through a company.”
For a full-length discussion on the IR35 legislation reform in the public sector, and how this affects your finances as a contractor or freelancer, read our expert analysis by Craig McCall, Operations and Technical Director at Gorilla Accounting.
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