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What is IR35?

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11/02/2021 UPDATE: IR35 reform coming into effect in April 2021

The IR35 reform in the private sector was meant to roll out in April 2020 but, due to the coronavirus pandemic, it was postponed for 12 months.

This gave contractors and end clients more time to organise themselves and prepare for the new IR35 rules.

The reform will apply to the private sector and says that employers will now assess contractors to figure out whether they’re inside or outside IR35. If a contractor is found to be inside IR35, the employer or agency has to deduct the relevant national insurance and tax. These changes only apply to medium or large businesses as well, so smaller companies can breathe a sigh of relief.

Do you know if you’re a small, medium or large business?

According to the Companies House Act 2006, c.46, part 15, a ‘small business’ is defined as:

381.

(3) The qualifying conditions are met by a company in a year in which it satisfies two or more of the following requirements–

1) Turnover (not more than £10.2m)

2) Balance Sheet Total (not more than £5.1m)

3) Number of Employees (not more than 50s)”

The onus for determining IR35 status will fall with the end client or agency, meaning contractors will not be the only one responsible for figuring out the right tax and national insurance contributions they must pay.

This is set to impact most contractors in the private sector and is estimated to add £1.3 billion per year to the Treasury from 2023. As contractor accountants, we can help you figure out whether you’re affected by IR35 and what you can do to prepare for the upcoming changes.

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What is IR35?

IR35, also known as ‘intermediary legislation’, was introduced in 2000 to tackle ‘disguised’ employment’. This is to prevent an employer engaging an employee on a contract basis, where the employer will avoid paying Employer’s National Insurance Contributions or providing employment rights and benefits.

If you’re found to be within IR35, you must pay tax and National Insurance contributions in the same way as an employee. According to HMRC, many people are not classifying themselves properly, which is leading to economic losses of around £1.2 billion a year. So far, HMRC estimates that the IR35 reform in the public sector, implemented from April 2017, has generated £410 million in additional revenue for the Treasury.

There was an IR35 reform in 2017 and, in 2021, there will be further changes to the legislation.

IR35 Example

Let’s put it into perspective. If an employee leaves work on a Friday and returns to work on Monday to carry out the same role as a contractor, saving the company money on tax, this is when IR35 comes 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:

Inside of IR35

It’s not your business that can be inside IR35, but the contracts you undertake. Operating through a limited company can still be a very tax-efficient way to run your business because not all projects will fall within IR35 and you can get the benefits of this structure.

There are several ways to verify that you’re an employee, not a contractor, as IR35 can be determined through several status tests based on historical case law which are applied to your written contract and working practices.

If you’re a genuine contractor, freelancer or consultant who’s in business on your own account, then it is likely that your engagements will fall outside IR35. It’s still important to be aware of the legislation and any potential changes to it, since you may have to prepare a defence if HMRC wishes to investigate.

If you want to know more about this, we’ve written a guide on HMRC IR35 investigations and what you need to know.

If you, on the other hand, possess the same benefits, responsibilities, and control as a permanent worker, then it’s highly possible that you’re inside IR35. This is because there are several factors you can keep in mind to check whether or not you’re a self-employed contractor and are inside IR35, including:

  • Control – are you under the direct control and supervision of your client? A contractor is not supervised like an employee is.

  • Substitution – are you allowed to provide a substitute if you’re unable to work? If not, then HMRC would consider this to be an indicator of a contractor of employment.

  • Mutuality of obligation – are there any expectations of future contract work after the current one expires? A self-employed contractor will work on a specific project that they’ve been contracted to do but there should be no further expectation of work by either side.

At Gorilla Accounting, we work closely with Larsen Howie, the specialist IR35 Contract Review provider for contractors, freelancers and consultants. For a breakdown of what's included in the IR35 Review and the discounted cost, please visit our dedicated page for IR35 advice.

Outside of IR35

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 is likely the most tax-efficient structure for your business.

Success or Failure?

The public sector changes came into play in 2017 despite disagreements from the sector. Since their introduction, IR35 has received wide-scale criticism.

Contractors find it confusing, and policymakers don’t believe it’s effective.

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.

In addition, the political landscape has changed significantly since its introduction and ministers have sought to blur the respective definitions of tax avoidance (legal) and evasion (illegal). It can, therefore, be said that a change in policy in this area is long overdue.

HMRC’s CEST Tool

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 tool gives HMRC’s view on whether:

  • IR35 applies to an engagement

  • the off-payroll working in the public sector rules apply to a public sector engagement

  • a worker should pay tax through PAYE for an engagement

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 worker’s responsibilities

  • who decides what work needs doing

  • who decides when, where and how the work’s done

  • how the worker will be paid

  • if the engagement includes any benefits or reimbursement for expenses

The answers should reflect the usual working practices of the engagement.

Concerns of IR35 in the Private Sector

There is a worry that, because the responsibility for employment status determination will fall to both the contractor and the end user, private sector businesses will start to take a more cautious approach and label their contractors within IR35 to be on the safe side.

This is because they would be liable for tax payments if the contractors were caught within IR35.

In addition, not every organisation or business in the private sector is aware of the new IR35 changes, so many have not yet prepared for the new rules.

A great number of employers are also concerned that they’re going to miss out on skilled contractors due to this IR35 reform.

How Can You Prepare for April 2021?

Companies must be aware of their new responsibilities if they plan on hiring contractors after 6 April 2020. This includes ensuring everyone in the company understands IR35 and its consequences (especially HR and recruiters) and executing an approach for the assessment of potential workers, mainly their employment status.

They should also have contingency plans in place if workers don’t want to switch to PAYE and implement processes like substitution into your operations.

As a contractor, there are several ways you can start preparing for the upcoming IR35 reform in the private sector. These include:

  • Taking the HMRC IR35 test, which will allow you to assess your current business practices.

  • Auditing your work practices after the test results, allowing you to assess how IR35 will impact you and how you can solve potential problems.

  • Taking ‘substitution’ into account, as the right to provide a substitute is often a key component in IR35 investigations.

  • Considering raising your rates, as working inside IR35 means paying more taxes than you initially thought.

 

Get in Touch with Us for IR35 Advice

If you’re looking for IR35 accounting, look no further. We can help you navigate the complicated IR35 rules and understand the impact the reform will have on your business, contact Larsen Howie, our specialist IR35 consultant, for more information.

You can also send Gorilla Accounting an enquiry, speak to our accountants on 0330 024 0406 or request a callback.

 

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