New IR35 rules or the 'off-payroll working rules will be introduced in April 2021 in the United Kingdom — legislation to make the contract workers pay the right amount of income tax and national insurance.
IR35 rules are designed to catch 'disguised employees' and ask them to pay tax and National Insurance Contributions (NICs). 'Disguised employees' or 'deemed employees' provide their services to clients via an intermediary, such as a limited company or Personal Service Company (PSCs), but would be an employee if the intermediary was not used.
This 'anti-avoidance tax legislation' was first introduced in 2000 by HM Revenue & Customs (HMRC); later reformed and planned to extend to the private sector from April 2020. Due to the Coronavirus outbreak, the enforcement of the new rules was pushed to April 2021.
There is multiple misinformation around IR35 and how it works. Let's decode and understand IR35, which all come under this legislation, and implement the changed rules.
What is IR35?
'Intermediaries Legislation, popularly known as IR35, is a set of tax laws applicable to contractors who work for clients through their intermediary.
The UK Government has introduced IR35 as ‘off-payroll working through an intermediary. With this new "Off-Payroll Tax," the firms have to assess the contractors' status; more importantly, they have to pay employment taxes along with the compensations paid to the contractor. If you come under this legislation, you may have to pay about 25% more tax every year.
But there are exemptions — IR35 will not be applied to someone who is a genuine independent contractor, freelancer, or consultant, having their own business. To clarify your status and identify whether you fall into this new Off-Payroll rules, you must understand how the legislation works, apply best practices to remove the risks of getting caught by the finance act, and have a defense prepared in case of an investigation by HMRC.
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The off-payroll working rules: who qualifies for IR35?
The off-payroll working rules will be applicable for the contractors using intermediary services but would-be employees to provide their services directly to a company. Here the intermediary could be a private limited company, a personal service company (PSC), a partnership, or another individual.
You might come under IR35 rules as:
- an employer who receives services from a person through an intermediary.
- A worker who provides services through an intermediary.
- A service agency providing a person’s services through an intermediary.
Suppose any of the conditions explain your employment status. In that case, the respective amount of income tax and National Insurance contributions will be deducted from your compensation from the employer and paid to the HMRC.
The government has also declared that the off-payroll working rules won't include the 1.5 million small businesses. In the private sector, it is the responsibility of the employer to decide whether an employee falls under IR35 or not.
How to determine IR35 status?
Firstly, it is crucial to understand that the contract workers or freelancers are not being judged on their IR35 status but the specific work contract. Hence, it has become clear about the terms and conditions mentioned in the worker's contract. If clauses indicate any employment to a particular worker, you should consider that contract as an employment agreement and determine the IR35 status of the worker.
Three factors play critical parts in deciding whether a worker’s contract falls under IR35 legislation or not.
When a freelancer is providing services as a company, not as an individual, it should be considered as a business. Here the skills required by the client to perform the service are the company's—not the individuals. So, the service provider company can assign any of their skilled representatives to carry out the job satisfactorily.
In the case of conscious avoidance of IR35 status, it is essential that the "right of substitution" is in the written contract and exists in reality.
2. Supervision, Direction, and Control
The client's control over the contract worker's services is crucial when determining IR35 status.
There are circumstances when it is acceptable for a worker to mutually agree with the client to provide a particular service within a specific timeline and at a particular place. Still, the worker should not be subject to any control or supervision from the client. Even the worker should be entitled to provide the service according to his convenience.
3. Mutuality Of Obligation (MOO)
Mutuality of obligation means there is an employment relationship between a client and a contract worker—there is an obligation on a client (work provider) to provide work and, similarly, an obligation on the individual to carry out the work with specific conditions.
In contrast to that, a self-employed individual will be liable to provide the service they are being contracted to deliver and finish with no other expectation of work. So, a self-employed individual will have the right to walk away from a contract early if they want to.
Some other indicators could interpret the relationship between a contract worker and the client as employment, such as financial risk, right of dismissal, and exclusivity rights.
To help you determine employment status, HMRC offers a tool for employers called the Check Employment Status for Tax (CEST). The tool was also introduced with the reforms to IR35 in 2017. This tool can help to find out whether someone's employment status falls inside IR35 or not.
What keeps you outside IR35?
Some general factors can play a vital role in keeping someone outside IR35. Here's the list of some common factors:
- Equipment and work location – It is common to understand that when someone is working for an organization, it's the organization's responsibility to provide the workstation and all equipment to do a job. Therefore, when someone is working from home using their device, they are probably outside of IR35.
- Employee benefits – The contract employees without the facility of pension contributions, sick pay, maternity allowance, and holiday entitlement also fall outside of the legislation.
- Financial risk factor – Someone using personal devices to complete a client's project and bearing the equipment's running costs is considered self-employed and probably can enjoy the IR35 tax exemption.
Generally, the self-employed workers are paid one-off sums for their complete service package instead of a fixed salary for ongoing work, which can probably keep them outside IR35. Therefore, when a contractor works for a firm using personal equipment, works from out of office, and is being paid a fixed remuneration for that work, it will usually be considered outside IR35.
When and how to implement the rules of IR35?
IR35 rules will be effective from 6th April 2021 on all public and medium-sized businesses within the private sector. The companies will be responsible for determining the employment status of all their workers for the proper tax deduction, including those who are engaged via an intermediary.
In the private sector, when you are working as a contract employee to a client, it's your intermediary's responsibility to decide your employment status for each work contract they offer you.
After the implementation of IR35
When a contract worker provides services to a client, medium and large-sized client companies will become responsible for deciding whether a contract employee offers service as a self-employed individual or as an employee to the organization.
In the case of a small-sized organization, it will be the responsibility of the intermediary to decide the worker's employment status.
When to start applying the rules of IR35?
Responsibility of a client in the private sector –
Find yourself falling under the conditions listed above and eligible for implementing the off-payroll working rule. You should start applying the rules when the changes come into effect on 6th April 2021. It is always good to start the rule implementation from the start of the tax year.
Suppose you do not identify the 'Disguised employees' in your organization and do not follow the taxation procedure from 6th April 2021. In that case, you may face legal and financial complications in the following financial year. If you meet the conditions of IR35 for two consecutive years, the date you need to apply the rules will be different.
What to do as a client –
To act according to this newly implemented anti-avoidance tax legislation, first, you need to determine the employment status of a specific role or every contract you have with an agency or individual worker. To support your decision, you'll need to:
- convey your decision on employment status along with the reasons to the respective employee and the person or agency you have a contract with.
- Keep detailed records of your employment status determinations along with the reasons for them and paid remuneration.
- Prepare a strategy to deal with any disagreements that come up from your resolution.
For all the contract workers coming under the off-payroll working rules, the employer must deduct and pay tax and National Insurance contributions to HMRC.
How to act –
From 6th April 2021 onward, as a client, you must provide all of your contract workers or the intermediary, or the agency you contract, an 'employment status and the reasons for your determination. It is good to follow the same rule for everyone regardless of your resolution regarding the off-payroll working rules.
This is a crucial step as you will be responsible for your employees' tax and National Insurance contributions until you tell the worker about your determination.
An employment status determination statement issued before 6th April 2021 is valid under the new rules as it is helpful for the decision-making about new tax rules. In the case of a change in the working practices or initiation of a new contract with any previous or current worker, you need to ensure that the same rules apply.
How to tackle the disagreement of a worker with your determination?
There is a chance that a worker or intermediary may disagree with you regarding the employment status decision. To handle such a situation, you should act tactfully. You should:
- ask for the valid reasons behind disagreement and consider the reasons given by the other party.
- Decide whether to retain your first determination or provide a new employment status according to the worker’s or agency’s view.
- Keep a detailed record of your decisions and their reasons; keep records for reasons for disagreement, any change (if the employment status is updated), and reasons behind that.
As an employer, you have to respond within 45 days of receiving a notification that the worker or agency disagrees with your employment status determination.
During your reconsideration procedure, you should continue to apply the rules in line with your original determination and calculate or deduct accordingly (which can be compensated later).
It would be best to inform the other party about your decision regarding the update of employment status in both conditions (agreement or disagreement) with your viewpoints supporting your decision.
If you fail to respond within 45 days, it will be your responsibility to pay the worker’s tax and National Insurance contributions on behalf of the other party.
What are the misclassification risks of IR35?
If you fail to classify all your work contracts correctly, there is a chance of being caught by HMRC, leading to some severe consequences.
In case of misclassification, you might have to bear the burden of charges like retroactive payments for pension, social contribution, and tax back payments, in addition to interest. In extreme cases, there are chances of imprisonment or punitive payment.
Like other legislative activity, the enforcement of IR35 also needs proper understanding, communication of the upcoming changes to your team, and professional services along with appropriate technology solutions.
With the implementation of necessary steps ahead of time, educating your workforce, and using the right tools, the employers will be able to avoid any potential liabilities and ensure the contract workers with accurate information on how the changes will affect them.