With IR35 being rolled out to the private sector from April 2020, businesses have just six months left to prepare for the new payroll rules which will be coming into force.
Changes to IR35
Currently, contractors who operate through their own personal service company (PSC) are responsible for ensuring they’re paying income tax and national insurance. From 6 April 2020 however, this responsibility will be passed onto the companies who hire private sector contractors.
It’s estimated that the change is going to affect around 170,000 individuals who operate through a PSC. Approximately 60,000 firms and 20,000 recruitment agencies are also expected to be affected.
Do the changes apply to my business?
If you use off-payroll workers and are considered to be a small company, you will be affected by the new rules.
A company is deemed ‘small’ if it satisfies two of the following criteria for two consecutive years:
- Your annual turnover is less than £10.2 million
- Your balance sheet is less than £5.1m
- You employ fewer than 50 members of staff
The rules which determine who is or is not within IR35 aren’t changing, only who is held legally responsible if those rules are not correctly applied.
What is IR35?
IR35 is used to describe tax legislation which was introduced back in 2000 in a bid to tackle tax avoidance. It applies to workers who are supplied to a company through an intermediary, such as a recruitment agency for example.
HMRC believed that self-employed workers were effectively being treated as employees but not being taxed through payroll as employees ought to be. This is what the Revenue considers to be ‘off-payroll’ services.
The new off-payroll rules were extended to the public sector in April 2017 and have seen some organisations lose, and struggle to replace, valued contractors. As such, projects have either been delayed, cancelled or seen costs increased.
IR35 has been largely criticised by tax experts and businesses who say it’s adding unnecessary costs and hardships for genuine small businesses. The government hopes that the new off-payroll tax will help to prevent this.
Tom Hadley, director of policy at the Recruitment and Employment Confederation, commented:
“IR35 rules are a huge problem for employers and contractors. They need to be clear to be effective. The last thing private-sector businesses need at this time of Brexit uncertainty is rushed or poorly-designed tax rules that add further uncertainty to an already fragile business landscape.”
What if I’m a contractor?
If you’re a genuine contractor, freelancer, interim or consultant who is in business on your own account, you should have nothing to fear from IR35.
If you’re a specialist who is currently working as a contractor or is considering doing so, a combination of factors should be considered to determine if you should operate as an employee or remain self-employed.
Mutuality of obligation
Employees and employers have to sign contracts that oblige employees to continue to work and for employees to pay them for that work.
This is what’s known as the mutuality of obligation. There is no continuing obligation on either side when it comes to self-employment agreements however because a self-employed individual can choose projects with no obligation to accept them, while a customer has no obligation to offer work to keep them busy.
Contractors who work through a limited company and who wish to remain outside of IR35 after April 2020, should ensure a genuine right of substitution exists throughout each contract.
To stay outside of IR35, you need to be able to show to HMRC that someone of equal competence, supplied by you, could have carried out the work to the same standard. In other words, that they’re paying for a service, not for you.
Should a client specifically ask for you to do the work and reject a colleague who is equally qualified, the Revenue may interpret this to mean that you are inside IR35.
Bringing your own tools and equipment is one way of proving to HMRC that you are self-employed, as is having several different customers at the same time.
Similarly, taking on financial risk by being willing to correct work in your own time and at your own cost, or being paid after submitting an invoice after completion of the task, is proof.
Checking employment status
Much furore surrounds the shortcoming of HMRC’s ‘check employment status for tax’ (CEST) tool. The tool was designed to help determine if a contract is inside or outside of IR35, but excludes the mutuality of obligation.
Prior to the Finance Bill’s publication in July 2019, the Institute of Chartered Accountants in England and Wales gave the CEST tool a vote of no confidence due to this omission.
HMRC currently assumes that a person has already established mutuality of obligation before they use its CEST tool, but it is looking to enhance the tool and is testing these ‘enhancements’ with the intention of rolling them out before April 2020.
Contractors who work inside IR35 on private-sector projects through a PSC will be able to reclaim 5% of gross annual income earned for administrative expenses in calculating the deemed employment payment.
‘Administrative’ includes costs relating to premises, admin support, accountancy advice, professional indemnity insurance, computer equipment, training, seeking contracts, printing and stationary, and bank or overdraft interest. You do not need to demonstrate this expenditure.
The 5% allowance is not available to employees as an expense they can draw from the company.
Options to prepare
If you’re a private-sector contractor who is likely to fall within IR35 next year, it’s likely you are already underpaying tax now.
It’s currently your responsibility to determine whether or not you are within the off-payroll rules. From next April, once this determination is no longer yours to make, this option will not remain on the table.
Just in case HMRC’s reform to the CEST tool is not delivered before next April, establishing whether or not you will be treated as an employee or within the off-payroll rules before using the tool would be a good place to start any preparations.
If it looks like you will fall within IR35, weigh up whether or not you would be better off becoming a permanent employee. Other contractors are deciding to close down their company to take on temporary assignments through an umbrella company.
Another option would be to get to grips with the finer details of your contracts in the event that HMRC sends you a full inquiry letter or formal information request.
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