In a surprise announcement, the Government has delayed introduction of the planned IR35 reform by one year because of the COVID-19 pandemic. This means that freelancers will continue to define their IR35 status when working in the private sector until the reform is implemented.
Chancellor Rishi Sunak had confirmed in his first budget that the Government would press ahead with the planned changes to the off-payroll rules (often referred to as ‘IR35’) in April 2020. The latest move, sensible under the circumstances, gives both clients and contractors more time to prepare for the reform.
The new rules are now expected to come into effect in April 2021 and only apply to services carried out from that date. From that point, medium and large organisations in all sectors of the economy will become responsible for assessing the employment status of individuals who work for them through their own limited company.
The reform does not introduce a new tax or apply to genuinely self-employed workers, who are outside the scope of the existing rules.
The changes are designed to reduce the tax avoidance generated by “disguised employment”, where individuals are effectively working like employees, but define themselves as self-employed contractors to reduce their tax liability.
This is a complex field. But stay with us. Contrary to some reports, it’s not all bad news. And you now have additional time to review the impact of the reform on your business.
What are the IR35 rules?
Let’s start with a quick bit of history. The IR35 rules were first introduced by HMRC in 2000. They apply to:
- A worker (often described as a contractor) who provides their services to a client through their intermediary, usually the worker’s personal service company (PSC).
- A client who receives services from a worker through their intermediary.
- An agency providing workers’ services through their intermediary.
If the rules apply, tax and National Insurance contributions must be deducted from the fees paid to the worker and paid to HMRC.
The rules are designed to tackle tax avoidance and ensure that a worker acting in a similar way to a direct employee of the client, an employee in all but name, pays broadly the same tax and National Insurance contributions as employees. Rather than taking advantage of the lower tax rates applied to companies and avoid national insurance altogether.
Originally, it was up to individuals to assess whether they came within the scope of IR35. But HMRC concluded that the growing number of PSCs was leading to abuse of the system and considered that PSCs could not be relied upon to operate the IR35 rules objectively. In April 2017 the rules were amended to require all public sector clients to identify “disguised employment” situations and decide whether their contractors fall under IR35.
The rules have met with opposition from business groups and professional bodies but HMRC estimate that the cost of non-compliance to the Exchequer will reach £1.3 billion a year by 2023/24.
The planned changes to IR35 will extend the public sector client responsibilities to medium and large firms in the private sector, who then become responsible for determining whether the freelancer should be regarded as a “disguised employee” and therefore treated as if an employee.
If the client determines that IR35 does not apply, then the client will pay the gross amount of the agreed fee to the PSC. But if it determines that IR35 does apply, the client must apply PAYE and NI and pay the net amount to the PSC.
Helpfully, where private sector clients are defined as “small” entities, they do not have to take responsibility for determining a freelancer’s employment status. And – regardless of whether the client is also the fee payer – neither the client nor fee payer need operate PAYE.
HMRC rules define both a corporate and non-corporate client as “small” if it meets at least two of the following tests:
- Its annual turnover is less than £10.2 million.
- Its balance sheet total is less than £5.1 million.
- The number of its employees is less than an average of 50 in the year.
From April 2021, medium and large private sector clients (in line with public sector clients) will be obliged to inform both the entity they contract with and the freelancer or PSC of their decision (a “Status Determination Statement” (SDS)) and the client’s reasons for it. Importantly, determinations must be made on a case-by-case, not a blanket, basis.
The amended IR35 rules require all intermediary recipients of the SDS (i.e. those in the chain other than the client and the freelancer or PSC) to pass the SDS and the reasons for it on to the person with whom they contract.
The amended IR35 rules for the private sector include provision for a PSC to challenge a decision that the freelancer falls within IR35, along with a mechanism for resolving such disputes (a “Status Disagreement Process”).
Where a party is initially liable to determine status and does not do so, or does so without reasonable care (i.e. it does not take independent legal advice and determine status on an individual basis), or if it does not fulfil any other IR35 obligation, it will be made liable for tax and National Insurance, even if it is not the fee payer. Where a party is liable for tax and NI but if it cannot be collected from that party, the rules have the effect of moving liability to the next entity in the labour supply chain.
How does HMRC determine the application of IR35?
The test of whether a contractor is an employee or a freelancer will vary, depending on the nature of the contract, the type of the project and practical working arrangements. HMRC takes a holistic view of this. But the key factors determining a decision include:
- Whether a “mutuality of obligations” exists, i.e. the employer is obliged to provide work and the worker is then obliged to undertake that work.
- Whether the client has a significant degree of control over how, when and where the contractor carries out the work?
- Whether the worker has to carry out the work personally, rather than being able to supply a substitute?
There are a range of other provisions, covering factors such as the availability of paid leave, pension arrangements and a requirement to work at that business’s premises.
Answering ‘yes’ to a significant proportion of these questions will indicate that a quasi-employment relationship exists and trigger the application of IR35.
By contrast, the arrangement will be considered self-employment if a set of defined factors are met, including a contract for services (not a contract of employment), there is no “mutuality of obligations”, the contractor is in business for her/himself (and is responsible for the success or failure of the business) and is permitted to work for more than one client.
An effective way to test your IR35 status is to use HMRC’s online tool, Check Employment Status for Tax (CEST) service, available here: CEST. But be aware that criticisms have been levelled at the operation of the tool. And that it must be used with care as HMRC have said that they will not abide by its conclusions if incorrect information has been entered.
The impact of these changes on freelancers
You will need to consider the potential implications of these IR35 changes if you operate a PSC. You should talk to your end clients and any intermediaries to see how they are implementing the new IR35 rules.
You might find that you can use your PSC for some clients but not others. But in all cases, you will need to assess the effect of the rules on your net income. Some private sector client organisations might decide not to deal with PSCs at all. In which case, you might find that you cannot use it to contract with some clients.
Some major banks have also indicated that they will not work with PSCs. Other regulated organisations might do the same. While some end clients might try to reduce the rate that they pay to PSCs if those clients have to pay tax/NI, to compensate for their resulting increased expense of engaging that PSC.
You may also want to review your contractual arrangements with clients to ensure contracts are compliant with the rules. This may have an impact on how work is directed and monitored, and how service delivery is defined. But this could provide better outcomes and longer-term benefit for both parties as respective roles, milestones and deliverables are defined with greater clarity.
Some wrinkles remain
The Institute of Chartered Accountants in England and Wales (ICAEW) has welcomed the changes announced by the Government to “support the smooth and successful implementation” of the new off-payroll working rules. These include a softer compliance approach in the first year to avoid penalising businesses trying to get it right. But they have warned that businesses still face several uncertainties about the new rules’ implementation and their impact.
- Whether the contractor will be aware that, if the client is ‘small’, it is up to them to comply with IR35.
- How a contractor who does not receive a status determination statement will know whether this is because the client has determined that the contractor is not deemed an employee or because the client is offshore which means that the contractor is responsible for applying the IR35 rules.
The lack of deadline by which the contractor must initiate the client-led disagreement process, potentially leaving the client exposed to a disagreement being raised for an indefinite period.
HMRC has published guidance on the reforms, plan to provide further advice in due course and will commission external research into the impact of the reform six months after implementation.
The reforms have yet to pass into law. But it is unlikely that there will be any significant alterations to the draft legislation. We therefore recommend that businesses take action now to ensure compliance.
This is a complex area. But the reforms are not as bad as sometimes presented. For those contractors that are genuinely self-employed and operate outside IR35, there should be no change. Remember, sole traders and freelancers who run their own business as an individual are exempt from IR35 legislation.
If you are unsure how these changes will affect you, now is the time to speak to your agency and end hirer to understand how they plan to implement the new rules and ensure your contract is fairly assessed. If your hirer concludes that you are working inside the IR35 rules, you should carefully consider your options going forward and avoid being drawn into potentially inappropriate tax avoidance schemes being promoted to contractors.
This may also be a timely opportunity to review existing and future contracts and assess them against the IR35 criteria to ensure they meet your business objectives.
We can minimise the impact on your business by helping you navigate IR35 successfully and ensuring you comply with the new rules.
If you have any questions or need advice on what to do please Contact Us for an initial discussion.