IR35 (introduced in 2000) determines whether a contractor is working through their limited company correctly. IR35 legislation tends to concern contractors and freelancers who provide services via an intermediary, or Personal Service Company (PSC). It does not apply to umbrella company contractors.
Changes to off-payroll working rules (IR35) in the private sector come into force on April 6th 2021. The reforms were scheduled for April 2020 but, in light of the Coronavirus outbreak, an 11th-hour delay meant an extension was announced in March. So, we’ve taken a look at what’s changing, who’s affected, and how you can prepare for IR35.
What is IR35?
IR35 is a tax law that targets disguised employment. A disguised employee is someone who falsely positions themselves as a limited company contractor to pay less tax. HMRC see this as tax avoidance.
Under the Intermediaries Legislation (IR35), if certain criteria are met, the earnings of a contractor’s PSC are considered a ‘salary’ on which Income Tax and National Insurance contributions (NICs) are payable.
Who decides if I’m inside or outside IR35?
April’s private sector IR35 changes follow similar reforms in the public sector from 2017. The new rules transfer the accountability for IR35 decision making from the intermediary to the end client. This is already the case in the public sector. Here’s how it works:
If you’re a contractor and you have a contract with an end client in the public sector, it’s your client’s responsibility to determine whether your contract falls under IR35. If IR35 applies, your client should add you to their payroll and deduct Income Tax and NICs before paying you – as they would with any other employee.
From April 2021, if your end client is a medium or large business in the private sector, the same rules will apply.
What are the rules for IR35?
IR35 tends to apply when three conditions are met:
- The individual (i.e. you) performs services for a client.
- The services are provided under a contract involving an intermediary (i.e. your PSC).
- The services are provided under a contract between the individual and the client, meaning the individual is classed as an employee of that client.
IR35 affects contractors who work and ‘act’ in the same way as an employee of their end client but get paid via an intermediary – such as their own limited company. Determinations are dependent on ‘tests’ for employment status, and the interpretation and application of past judgements from case law.
How is my IR35 status determined?
There are several ‘tests’ of employment used to determine the IR35 status of a contract. Here are the three most significant. Control, Right of Substitution, and Mutuality of Obligation.
- Control is often grouped with ‘supervision’ and ‘direction’. In IR35 terms, ‘supervision, direction, and control’ refers to the level of control the contractor has over the work they carry out for their client. So, if you decide how your contract gets completed and can perform your work according to your own schedule, it likely indicates that you have the necessary control over what you do. In this instance, you would be outside IR35.
- The Right of Substitution is the right a contractor has to send a replacement to perform services for the client on their behalf. For a contract to fall outside IR35, it should specify that a substitute can complete work on your behalf. It is an important distinction when proving your status as a professional PSC, as opposed to an employee.
- Finally, Mutuality of Obligation refers to a shared obligation between the worker and the work provider (client). In simple terms, the client has an obligation to provide the work and the contractor has an obligation to complete it. This constitutes a contract of employment. If your contract states that you cannot take on another client while working for your current client, it could mean that you’re inside IR35.
How does IR35 work?
Here are two examples of how IR35 determinations work in practice.
- Contractor A provides services to their end client via a PSC.
- The contract stipulates that the contractor should follow set processes, complete company training, and provide the service themselves.
- The client provides regular work to the contractor, who also gets a company email address, and is even issued a company laptop to complete assignments.
In these circumstances, the contractor’s likely to be inside IR35.
- Contractor B also provides services to their end client via a PSC.
- However, other than a deadline for the assignment’s completion, the client makes no other specific demands of the contractor.
- The contractor works on other contracts simultaneously and performs their duties using their own equipment. They have the freedom to work where they want, when they want, and they’re entitled to pass work onto a fellow contractor at their discretion, so long as the work gets completed to the expected standard.
In this instance, HMRC should deem the contract outside IR35.
Did you know…? The legislation’s known as ‘IR35’, as that was the reference number for the press release that announced it.
What are the 2021 changes to IR35?
Changes to off-payroll working in the private sector come into effect in April 2021. The new rules transfer the responsibility for assessing the IR35 status of a contract from the individual performing the work through their intermediary, to their private sector client. The changes intend to ensure that those who bill for their services via a limited company – while working in the same way as an employee – are paying the correct amount of employment tax.
Under the new regulations, unless your end client is a ‘small business’, you are no longer responsible for assessing the IR35 status of your contract. That decision will instead get determined by your end client. If your contract is within IR35, then your contract income will be subject to Income Tax and NICs. Therefore, your tax and NICs will get calculated – and deducted – by either your client or recruitment agent.
Those deemed inside IR35 will get taxed in the same way as an employee. However, this doesn’t necessarily mean they’ll receive all the statutory benefits associated with employment. This includes things like holiday and sick pay, as well as maternity and paternity pay.
How do I avoid IR35?
Contractors with contracts inside IR35 pay more tax than those whose contracts lie outside the legislation. There are steps you can take to try to ensure that the private sector’s off-payroll reforms do not apply to you:
- Ensure you have an authorised, up-to-date, business-to-business contract. One that doesn’t name you direct.
- Get ‘Confirmation of Arrangements’ – signed by your client.
- Confirm the control you have over your contract and exercise your right to substitution.
- Keep evidence of how you acted in a different way to your client’s employees.
- Behave more like a business and less like an employee.
For more advice on the measures you can take to ‘avoid’ IR35, click here.
How can I prepare for IR35 changes?
It’s important to consider the wider implications of your potential IR35 status, beyond what it could mean for your taxes. You need to get your affairs in order before the deadline of April 6th 2021. For instance, if you’re going to switch from being self-employed to a position of employment, there are plenty of things it could affect. This includes your:
- Life insurance policies
- Income protection policies
- Pension contributions
- Private medical insurance
Going back onto a payroll might also mean you’re treated differently for financial products like mortgages. Fortunately, Danbro Financial Planning can help contractors like you with your financial arrangements. Find out more, here.
Check Employment Status for Tax
If you ‘have, or expect to have, a work contract’ and you want to know whether you’re likely to be classed as employed or self-employed in relation to IR35, you can use the free ‘Check Employment Status for Tax’ tool from HMRC.
CEST, as it’s more commonly known, is a useful tool both for contractors and those who hire them. The service is anonymous, and will assume that you have a contract in place. To use CEST, you’ll need to know: the contract details; the worker’s responsibilities and how they’ll get paid; who (client or worker) decides what work needs completing, as well as where, when and how it’s completed; and whether the engagement “includes any corporate benefits or reimbursement for expenses.”
What should I do if I’m caught by IR35?
Depending on your circumstances, here are some options if your contract is deemed inside IR35:
- Continue to work via your PSC. This will be via the deemed salary model, in which Income Tax and NICs get deducted by the entity responsible for paying your company (except in cases where the end client is classified as a ‘small business’).
- Take a permanent role. That is, stop contracting altogether and take on a permanent position.
- Switch to an employment umbrella company. By switching to an employment umbrella company, you’ll have the capacity to work flexibly as a contractor, whilst benefitting from employee benefits.
Get a free calculation of your take-home pay now to find out what you’re likely to earn whether you’re inside or outside IR35, as well as via our umbrella company.
Umbrella Companies & IR35
IR35 does not apply to umbrella company employees. So, if you’re employed by a compliant umbrella company, like Trafalgar, you won’t get caught by IR35. Instead, the legislation targets those who should be being taxed as employees, but aren’t.
By working through an umbrella company, you’ll become an ‘employee’. This entitles you to statutory rights like holiday pay and maternity/paternity pay. You will also have the valuable asset of continued employment. This is particularly useful when accessing financial products, like credit and mortgages, at more attractive rates.
Register for Umbrella, today
Trafalgar are experts in IR35. We provide a wide range of accountancy and employment umbrella company solutions, as well as independent financial advice. Our dedicated team can provide expert guidance and support for you, whether you’re inside or outside IR35.
You can transfer seamlessly from working via a PSC to contracting through our umbrella company – and back again – meeting the needs of each assignment. What’s more, for a small fee, we’ll provide an independent working practices review to support a decision on your IR35 status.
Register online now and one of our specialists will give you a free consultation. They’ll help you find the most suitable option for your circumstances. Registration is swift, simple, and stress-free, and we can get you set up in a matter of minutes.