Both small businesses and freelancers are getting prepared for a forthcoming change in a part of tax-avoidance legislation. Coming April 2021, employers in the private sector will have to conform to the same rules already followed by the public sector regarding IR35 – and following the tip-off from the Federation of Small Businesses, this alteration in tax-avoidance legislation will be felt by both companies and contractors.
Originally, Gordon Brown introduced IR35 (also referred to as the ‘off-payroll working rules’) to prevent employers treated as contractors from avoiding tax. However, the notorious act of the legislation sometimes implicates businesses that feel they hired contractors the right way, only to be disagreed with by HMRC.
NOTE – This article was first published in 2020 and has been updated to reflect the change in date of the rule changes.
When will the IR35 changes happen?
As from April 2021, new IR35 changes will be implemented for private sector contractors that will transfer responsibility from contractors to large and medium companies to assess IR35. The 2021 reform will bring private sector IR35 in line with the public sector, where the reform was implemented in 2017.
As a result, private-sector employers are faced with a difficult choice; it’s either they treat contractors as employees, bearing the extra costs and responsibilities that it offers, or treat contractors as contractors, and risk a huge fine if a different view is taken by HMRC.
However, it’s possible to continue working through a limited company even if your contract is deemed to be inside IR35. You’ll need to ensure you pay the correct PAYE tax and National Insurance (NI) for any contract which is inside IR35 because you are, in the eyes of HMRC, an employee.
You can, however, manage this through your limited company. This can lead to problems for some though, as many contractors do not pay the correct amount of PAYE, VAT or Corporation Tax to HMRC, instead deferring these payments to keep a company afloat or using the money as a ‘personal expense account’. If you think you are unlikely to be able to make the correct payments to HMRC then you need to talk to an insolvency specialist urgently.
Where do you stand in IR35?
Are you inside IR35 or outside?
The way employees are treated differs from how contractors are treated, this is why IR35 was introduced. Contractors receive flat payment and can easily be dismissed if their service(s) is no longer needed. With employees, it’s a must that an employer provides a workplace pension, sick pay, paid holiday, among other benefits, and also pay employer’s National Insurance Contributions.
Most contractors carry out operations as limited corporations, either as solo-person companies or group/umbrella companies. Contractors rarely operate as sole traders; it exposes them to risk due to unlimited liability. Meanwhile, companies are cautious when it comes to hiring contractors in case they are perceived by HMRC as employees. Also, it means contractors will pay less tax since they are operating as a company.
In as much as contractors carry out their operations as a company, it does not stop them from being called an employee; this is where IR35 is relevant. Generally, ‘If it looks like a duck and quacks like a duck, it’s a duck,’ says IR35.
Simply put, since contractors function like employees, with similar responsibilities/obligations, then contractors could be treated as employees for tax purposes. As a result, HMRC pays close attention to what it considers as ‘Personal Service Companies.’
Personal service company – What does it mean?
Although you may question how the name sounds, a personal service company is described as a company through which contractors function to offer freelance services (since most companies will not employ a sole trader). There is no legal definition for this term; however, HMRC uses it to describe businesses that may be used by contractors as a cover but are also employees in all but name.
This leads to a double problem, which will affect not just the contractors, but the business that wants to hire them. A company may not want to risk hiring a contractor if they feel that the contractor might be considered by HMRC as an employee. As a result, both the contractor and the business suffer loss. And this is what most small businesses are fearful of coming April 2020.
Can I check my IR35 employment status?
There is an online tool offered by HMRC that can be used to Check Employment Status for Tax (CEST); this tool can be used as a general guide to knowing your status. However, industry bodies, like the Association of Independent Professionals and the Self-Employed (IPSE), still feel this tool is not reliable. Therefore, recruitment agencies, contractors and end-clients should not rely on this tool completely to determine IR35 status.
CEST biggest problem: The MoO factor
CEST doesn’t factor in the Mutuality of Obligation (MoO); this is one of the biggest problems with this online tool. MoO is among the defining features of employment, it specifies the obligation of employees towards their employers, and vice versa. Most of these obligations are not applicable to contractors. For instance, contractors can choose how they want to work, where they want to work and can assign work to an associate if the need arise; while the client is under no obligation to offer more work to the contractor. In some recent IR35 tribunals, Mutuality of Obligation has been a decisive factor; this is why the CEST tool should not be relied on completely.
What can businesses and contractors do about IR35?
Most people fear that changes to IR35 will bring an end to freelancing, this feeling is totally exaggerated. There is a bright side for contractors and businesses; which is taking the right steps to ensure they don’t fall a victim to the forthcoming alterations.
If you can recall, IR35 only applies to a role, and not the individual. So the fact that it did not apply to you in your previous assignment does not mean it won’t in your next assignment. For each assignment taken as a contractor, it’s crucial that you are able to show that you are not an employee but in business on your own account.
Tips for contractors to prove that you are ‘in business on your own account’
As a contractor operating through a limited company (personal company or under an umbrella company), you may be asked by HMRC to provide evidence that you are freelancing and not an employee. To make your case, you can adopt any of the following.
1. Do not name your company after yourself
HMRC is aware that a business named after an individual may as well be that individual, and this fits their description of a Personal Service Company. Giving your company a business-like name will show that your company is distinct from you, and you have the ability to delegate task to another individual where necessary. Company employees are not able to delegate tasks this way, so you can use this to prove yourself as a contractor and not an employee.
2. Highlight how your work situation is different from employees
Genuine employees usually have certain work conditions, like minimum work hours, pension arrangements, subsidised services, and other benefits. Also, the employer is responsible to provide his/her employees work to perform, and the employees are obligated to do so. The employer can also stipulate how, when and where the work should be done. As a contractor, you should be able to show that you are not obligated to any of this.
3. Keep client correspondence
If there is an email or correspondence in your possession that clearly shows that you can operate on your own (as a contractor to offer a service) and not under instruction/supervision of the manager at the business, you can show that as proof.
4. Have marketing materials of your own
You need to be able to show HMRC that you market your services as a contractor actively and independently. Ensure you have a listing on post adverts, relevant services website and print business cards, anything that can show that you operate on your own account. To prevent falling a victim, do not use a business card that has your client’s brand on it.
5. Maintain your own office and have your own business insurance
Having an office that’s well-equipped, even if it means having one in your home, will show that your operations as a contractor extend beyond the client you are working with at the moment. Also, if you invest in your software licenses, professional memberships, and trade literature, it can be useful. A nice way to demonstrate that you are not an employee is to take out your own business insurance, like professional indemnity insurance.
6. Invest in your professional development
Employees hardly sponsor their own training, so another way to differentiate yourself from your client’s employee is to sponsor your own training. You may be required by some professions to take continued professional development (CPD) to stay qualified. When you pay for this, you are also reaffirming your status as a contractor.
7. Having multiple clients at the same time
Arranging this is not always possible, but if you can split your time evenly between multiple clients, it makes it much difficult for HMRC to see you as an employee. On the other hand, you may not be able to convince HMRC if you have a more uneven split; for instance, if 90% of your income comes from a single client.
The more evidence you have, the more likely it is for HMRC to accept that you are operating a business of your own.
8. Make sure there is a contract between the businesses
Having a correct contract between the businesses will help make sure that you can stay the right side of IR35. Having the right terms and clauses could potentially save you a large bill. In this example HMRC lost a court case because of the contract – IT contractor has £240k bill torn up after IR35 win against UK taxman
IR35 tips for businesses that hire contractors
If your company hires contractors, it’s important you review your relationship with them to make sure they are not under IR35.
Starting in April 2020, you are responsible for determining if a worker is a contractor or an employee for tax purposes. Companies will have to offer contractors a Status Determination Statement, which clearly states their IR35 status (inside the rules or outside) and explains why. You should be able to avoid any penalties provided you support your decision with enough evidence and file the right tax documents.
You will need to:
- Review every relationship with contractors or consultants.
- Accurately and clearly state your terms of engagement
- Provide contractors with their Status Determination Statement
- Consider changing some contractors that fall within IR35 into employees. And if this solution is more practical for you both;
It’s worth noting at this point that the new IR35 Rules will only affect medium and large private sector organisations, so “small” end clients are set to be exempt – the definition of which is based on the Companies Act 2006 definitions.
The new rules will also only apply to medium and large businesses in the private sector who are the end user of the worker’s services and to the fee payer, if different, such as fee payers in the recruitment sector. The Government have indicated that they intend to use ‘similar criteria’ to that found in the Companies Act 2006 to define a medium-large business. Under current legislation this is broadly a business that has two or more of the following features:
- a turnover of more than £10.2m
- a balance sheet total of more than £5.1m
- 50 employees or more
Do I need to give my contractor employment rights?
Some of the contractors who fall inside IR35 and are treated as employees for the purpose of tax may feel entitled to full employment status, as well as the protection it offers. A lot of problems may arise as a result of this, like entitlement to backdated holiday pay, which needs to be handled on a case-by-case basis.
Get free advice today
If IR35 or the upcoming changes are going to cause problems for you or your company you need to get in touch as soon as you can. Call us on 0800 975 0380 now or email us on [email protected]
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