What is IR35?

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 that is trading inside or outside of IR35, but it is each contract that the company undertakes. If caught by IR35, it’s typically more 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.

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. 

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 2017, when 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 clamp down 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. Since their introduction, IR35 has received wide-scale criticism.

Contractors find it confusing and policy-makers 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 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:

• the intermediaries legislation (known as 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.

In the Autumn Budget statement 2018, the Chancellor announced that the IR35 will be extended to the private sector:

 “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.”

This change has been delayed until April 2021 and will only apply to contracts where the end client is a medium or large business. The new reform also means that the responsibility for determining IR35 will lie with the end client or agency.

According to the Companies House Act 2006, c.46, part 15, a ‘medium or large 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 (nor more than 50s)”

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 back tax payments if the contractors are 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.