IR35 is an anti-avoidance legislation imposed by the UK tax authorities over the past 20 years where a worker creates a false self-employed status by working through an intermediary, i.e. personal service company (PSC). A PSC is a company where there is only one employee or officeholder, which supplies that individual's services to a business.
HM Revenue & Customs (HMRC) claim that operating under these arrangements offers contractors, and those that engage their services, with several distinct advantages – not only the potential tax savings, i.e. Corporation Tax at 19% after deduction of allowable expenses and flexibility of withdrawing money as dividends with tax rates of 7.5% - 38.1%, instead of being taxed as an employee with IT at rates of 20% - 45%.
Under the original IR35 rules, the worker’s PSC was responsible for determining the employment status of the worker and, where contracts fell within IR35, the PSC was responsible for calculating deemed employment income and deducting both PAYE and NIC.
HM Revenue & Customs (HMRC), UK’s tax authority, brought in additional measures to tighten the regime and catch workers who were not applying the correct treatment of the IR35 rules. The additional measures, known as the off-payroll working rules, transfers the responsibility for determining the employment status to the entity in receipt of the services of those contractors providing services through a PSC.
However, HMRC have introduced the new measures in stages, with the first stage in the public sector, already in operation. The first stage was introduced in April 2017 where workers provide services to a public body/authority.
From April 2020, contracts in the private sector are caught but only where the end-client is a medium or large company. This is likely to include both companies with UK resident status or companies with a place of business in the UK.
It is intended that those who are genuinely self-employed should not be affected by the off-payroll working rules and for contracts where the end client is a small company, the original IR35 rules will remain in place.
This of course has a major impact on UK corporate bodies and the UK business environment. Many businesses had previously been encouraging workers to use PSCs as they provide increased flexibility for both parties and reduce payroll costs to them.
The new regime increases costs to the end client due to the additional cost of Employers NI (13.8% of deemed salary) and payroll administration costs. These costs are expected to be passed to contractors by reducing their day rate/contract fee.
Due to the risks imposed on them, many businesses such as banks including Barclays, RBS, Lloyds and HSBC are announcing that they are taking a blanket approach and no longer engaging with any contractors to avoid dealing with the off-payroll working rules and, instead, they will only have employment contracts.
By doing so, many contractors are expected to receive a salary lower than the fees previously received by, not only the cost of Employers NI, but the cost of the employer’s pension contributions, holiday pay etc. With the reduced payment for service, inflexibility of employment contracts and higher tax rates at 20% - 45%, this is creating frustration within industries who require the flexibility of contractors.
As mentioned before, the new rules also affect the fee-payer, which includes recruitment and freelance agencies, some of which are following the actions of the larger corporate banks. Where they continue to engage with contractors through a PSC, the fee-payer must deduct PAYE and NICs as payroll on the net amount of the PSC’s invoice for services provided.
The government has, in recent months, been lobbied to delay and revise the introduction of rules to the private sector and, on 7 January this year, they delivered a pre-election promise to launch a review of the changes. Many are expecting the review to conclude by mid-late February which this does not give much time for the smaller agencies to put in place procedural changes.
Determining Employment Status
Businesses and agencies will be able to use the HMRC’s Check Employment Status for Tax (CEST) service, which is available to help businesses determine whether the off-payroll working rules apply.
It is essential to not base decisions solely on the contents of the written contract but to also look at the characteristic of the relationship between the worker and the end-client. We recommend that end clients should take a cautious approach when applying the rules and take time to identify each contract on an individual basis to prevent legal action being taken against them.
Contractors who feel they should not be deemed an off-payroll worker can appeal a decision with the end client, but the ultimate decision whether to accept or dismiss an appeal lies with the end client.
Businesses must not wait until April 2020 to respond to this legislation, as HMRC has said it begin robustly reviewing compliance as soon as the new rules become law.