Don’t get caught out by the IR35 changes
The Off-payroll working rules, otherwise known as IR35 is not new legislation. It was introduced to address situations where individuals provided services to a business via a personal service company (PSC) and thus potentially mitigate or avoid any employee income tax and national insurance liability. The IR35 rules are now being extended in application to all medium and large private sector businesses.
What is a PSC?
A PSC is a limited company which typically has only one employee or director who will also be the sole shareholder generally. The sole purpose of the PSC is to provide services to businesses, such services being those carried out by the individual employee or director of the PSC.
The PSC would directly receive remuneration from the business receiving the services and the individual would be paid by way of dividends and a basic salary from the PSC.
The PSC model is a popular for individual contractors or freelancers to provide their services to businesses as it affords the individual the protection of company limited liability as well as the tax savings mentioned above. From the business’ point of view there are also benefits as it allows flexibility in engaging personnel, particular in industries where demand can fluctuate. The business will also not be responsible for employee benefits and protections and will also make savings in terms of national insurance contributions and payroll requirements as they will not be responsible for deducting tax under PAYE.
This is where the extension of the IR35 rules, which previously applied only to the public sector, comes in.
When does IR35 apply?
In general terms businesses should be considering IR35 when the relationship with the individual providing the service would be regarded as an employment relationship where it not for the PSC acting as an intermediary between the two. The rules also apply where an individual provides services to a business which would constitute the individual holding office, such as a directorship, were it not for a PSC intermediary.
The fun part of all of this is that there is no set legal test to determine this issue. Instead there is a myriad of case law in which the factors relevant to this question have been debated. In addition HMRC has provided guidance in respect of situations where an employer-employee relationship exists. To assist with this and the changes to IR35, HMRC will be reforming its Check Employment Status for Tax tool in order to increase its accuracy, however it is always important to consider this issue carefully and seek advice from employment law specialists where necessary.
In summary, the factors which will be relevant will be:
– Control – how much autonomy does the individual have in regards to how they work, when they work and where they work;
– Financial Risk – are fees conditional on particular results or outcomes?
– Substitution – Can the individual appoint a substitute or is there a requirement for that specific individual to carry out the work; and
– Mutuality of obligation – does the business have an obligation to provide work and must the individual accept the work assignment.
There are also other factors such as benefits and whether or not the business provides equipment to the individual for the purposes of the service.
A crucial point to note is that the IR35 rules can apply irrespective of whether your contract for services with an individual’s PSC states otherwise. The reality of the situation will be relevant as opposed to the label attached to any particular contract. For example, if a contract between a business and PSC allows for a substitute but the reality is that the business does not allow a substitute or makes it practically impossible for the PSC to provide one it may well be that IR35 applies.
What do the IR35 rules mean and how are they changing?
In essence the IR35 rules impose an obligation on the business receiving the services to determine the tax status of the individual providing the service, communicate that to the individual and make relevant deductions and contributions for tax and national insurance.
Currently this obligation under IR35 only applies to the public sector and businesses in the private sector have no responsibility in regards to an individual’s tax status. This is all changing from 6 April 2021.
As of 6 April 2021 the IR35 rules are extended to apply to all medium and large public sector businesses. This means going forwards these businesses will be responsible for determining the tax status of an individual providing services via a PSC and making relevant deductions and contributions.
Is my business large or medium?
There are three factors which are relevant to determining whether a private sector business falls under the IR35 rules. These are as follows:
– Turnover of more than £10.2 million;
– A balance sheet total of £5.1 million;
– More than 5 employees
Where two or more of the above criteria are satisfied a business will be deemed large or medium and will fall under the IR35 rules, thus becoming responsible for determining an individual service provider’s tax status.
This will clearly impact a large number of businesses moving forwards and there are already a lot of examples of businesses becoming reticent to engage contractors via PSCs and actively moving towards hiring people as employees instead. This has, in turn, led to something of a talent drain in many larger companies where individuals have been reluctant to lose out on the benefits of providing services via the PSC model.
How should businesses prepare?
Clearly the changes to IR35 will impact many businesses and will require a change in how they work in many instances. The application of the rules will hit businesses who engage contractors via PSCs by exposing them to increased tax risks and expenses. It is therefore important to take steps to prepare for the changes.
It is firstly important to undertake a process of reviewing current engagements with intermediaries such as PSCs and agencies placing service provider individuals within businesses. This is key to understanding the potential impact of the changes and the on going exposure the business will face. It is also important to put in place proper processes for determining the tax status of individuals providing services via these intermediaries. Our IR35 experts can assist with these matters and advise on steps and policies which may be required.
In addition, where relationships with service providers are genuinely independent contractor relationships it is important to ensure properly draft bespoke contracts are put in place which accurately reflect the situation. Whilst the contract will not be the determinative factor in ensuring service providers fall outside of IR35, this is an important starting point.
Finally, an alternative route that some businesses are treading is to move towards engaging the relevant individuals as employees. If this is the way forwards for your business it is important to speak with employment law specialists to ensure the proper contracts, policies and procedures are put in place.
The IR35 changes will undoubtedly result in some big changes in terms of businesses engaging service providers and labour generally but with proper preparations and focussed advice the impact of those changes can be mitigated.
For an initial discussion regarding IR35 please feel free to give me a call on 01273 447075 or email at [email protected].