The reform of IR35 arrangements were announced in the November 2018 budget, with a plan to switch the liability for tax payments from self-employed contractors to private organisations or ‘engagers’. The changes are due to be implemented in the new tax year, in an attempt by the government to prevent ‘disguised employment’ and tax avoidance. All engagers will need to be compliant with the new system from 1st April 2021.
What is IR35?
Forming part of the Finance Act, IR35 is tax legislation focussing on two key tax laws. It aims to ensure workers and companies pay tax and National Insurance (NI) contributions correctly.
When companies hire a worker on a self-employed contractor or consultancy basis, via a limited company, they stand to save paying Employers NI and pension contributions, there is no need to offer the worker the same rights and benefits as their employees. If the worker could be considered to be an employee, for example, working full time hours and working solely for that client, they are ‘deemed employees’ under IR35 by HMRC.
‘Deemed employees’ are then required to pay income tax and make their own NI contributions, which would impact net income significantly, cost thousands of pounds in extra tax for the consultant.
The IR35 system has been viewed by many as too complex, with the potential for incorrect identification as an ‘inside IR35’ contract leaving many genuinely self-employed contractors at a financial disadvantage.
IR35 changes have already been implemented across the public sector since 2017, and will now roll out across the private sector.
What are the IR35 changes?
From April 2021, there will be changes to how medium and large private sector businesses can engage with contractors and consultants. The IR35 changes will mean:
- medium and large private organisations, who use self-employed workers to carry out services, will be responsible for setting the IR35 status, and not the worker. The 5% personal service company (PSC) allowance will no longer be permitted.
- the worker will stay responsible for determining whether the IR35 rules apply when working with small private sector clients. The 5% PSC allowance will remain available.
Preparing for IR35 Changes
To help prepare for IR35 changes in the private sector, organisations will need to take steps to ensure that any contractors they use are placed ‘inside’ or ‘outside’ IR35 in accordance with their contracted working arrangement.
If carried out correctly, the changes should help to raise tax revenue that would have otherwise been lost, and help to protect the tax allowances entitled to legitimately self-employed workers.
Determine the size of your company
Private sector organisations with an annual turnover of more than £10.2 million, must implement the rules, under the simplified test. The rules must be applied from the start of the tax year following the end of the calendar year in which the conditions were met.
The simplified test cannot be used by a company, a limited liability partnership, an unregistered company, or an overseas company. For private sector companies, section 382 of Companies Act 2006 applies in line with the small companies regime.
If your private company, or third sector charity, meets two or more of the following conditions you’ll need to implement the rules from the 1st April 2021:
- an annual turnover of more than £10.2m
- a balance sheet total of more than £5.1m
- more than 50 employees.
You’ll need to stay aware of changing circumstances. If you do not meet the conditions on 6 April 2020, your circumstances may later change, and if you then meet the conditions for two consecutive years, the date you need to apply the rules will be different. You must apply the rules from the start of the tax year following the end of the filing period for the second financial year in which you met the conditions.
There are also rules around group companies. If the parent company of a group is medium or large, their subsidiaries will also have to apply the off-payroll working rules.
Determine the employment status of workers
Medium or large private sector organisations must use reasonable care to determine the employment status of workers. To help you get your decision right, HMRC have developed an anonymous tool to help you check employment status for tax (CEST).
The CEST tool can be used to identify worker status, based on contractual terms*, and must be done for every contract you have with either an agency or worker. If the engagement arrangements change during the course of the contract, the status needs to be reassessed.
*HMRC does not consider CEST findings conclusive if it considers at any point that the contractual terms or structures were contrived to achieve a particular determination.
The accuracy of the CEST tool is enhanced by a collaborative approach between engager and consultant to ensure the correct status is achieved.
Once the employment status is determined, the company needs to share this information with the worker/agency, along with the reasons for the decision. This must always happen whether off-payroll working rules apply or not. If the determination is not passed on, the worker will assume liability for deducting tax and NI contributions and passing them to HMRC, until the determination is received.
The working status determination needs to be shared on or before the contract date or before the work starts. If the worker disagrees with your determination, then the decision may need to be re-evaluated to address the disagreement. A response should be given within 45 days of receiving the worker’s disagreement. During this time, you should continue to apply the rules in line with the original determination.
The response to the worker should inform them whether the determination has changed or not. If you fail to respond in the time frame, the responsibility for paying tax and National Insurance contributions will become the company’s.
Accounting and taxation
If the contract falls under off-payroll working rules, and the tax and national insurance is deducted by the organisation, the contractor’s intermediary, typically a PSC of the worker, will still need to account for this income. ACCA have a helpful guide to support accounting in relation to IR35.
Once a working status determination is made, it may be in the worker’s best interests to evaluate the best route of employment by weighing up the financial and practical benefits of self- employment versus the advantages of company employment.
IR35 rules can already be difficult to navigate, so if you need further information about the reform plans or need help getting your business ready for the IR35 changes, please be assured you can call our Corporate Tax team in Warrington on 01925 830 830, or in our Manchester office on 0161 905 1801, for any guidance.