What is IR35 and What Does it Mean for Your Business?

What is IR35 and What Does it Mean for Your Business?

Introduction

The IR35 is a UK tax law enacted in April 2021and it influences how businesses and contractors do business together. Also known as the ‘off-payroll working rules,’ it addresses a previous loophole in tax law for individuals who provide services to businesses via their own limited company or intermediary instead of as an employee.

The IR35 might trigger significant changes for UK companies and businesses with contractors in the UK. If you are still determining whether this might be relevant to managing payroll, read on to learn more about what IR35 is and how it could impact you.

Who Does the IR35 Impact?

The IR35 affects contractors that operate via an intermediary and the companies they provide services for.

Contractors

The contractors impacted are those who are registered as:

  • A limited company
  • A personal service company
  • A partnership
  • An individual

Using one of these business structures has traditionally proved beneficial to contractors for collecting payments and paying less tax. However, the UK government flagged that many people were unfairly taking advantage of this system. Some workers were invoicing companies for their services as contractors while performing as employees.

Any worker that technically meets the criteria of an employee — despite operating as a limited company — will now be classified as a ‘deemed employee.’ This will activate several employers and taxation responsibilities.

Companies

These latest reforms apply to businesses in the Private Sector, following Public Sector reforms in April 2017. Companies that receive the services of a contractor are now responsible for determining the IR35 status of their workers.

This is primarily relevant for medium and large businesses. Small businesses are exempt from the rules as long as they fall within two of the three criteria:

  • Have up to £10.2 million turnover
  • Up to 50 employees
  • Up to £5.1 in gross assets

The IR35 regulations can also impact agencies that provide services through intermediaries.

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What Does Being Subject to IR35 Legislation Mean?

Being subject to IR35 legislation presents significant impacts on company responsibility. Companies are now responsible for defining the IR35 status of their contractors. Previously, the UK tax authority, the HMRC, and the contractor were responsible for determining the IR35 status. Businesses must run their checks on the status of the contractors. They must also be careful about classifying workers.

So how can a company correctly make this distinction, and what actions must they take? By law, a contract worker can be defined as ‘inside IR35’ and ‘outside IR35’. Let’s dive into what this means.

Inside IR35

Inside IR35 is when a contract worker could legally be defined as an employee by IR35 law. They are inside IR35 and, therefore, subject to the same taxes as an employee. In this case, a company must act in the same way as they do with employees, such as:

  • Deduct income taxes at the standard employee rates
  • Deduct employee National Insurance Contributions (NICs)
  • Pay employer National Insurance Contributions
  • Pay an Apprenticeship Levy

Outside IR35

A contractor that is correctly defined as a contractor and is not misusing their status to avoid paying certain taxes is deemed outside IR35. They are legally considered self-employed. Thus, they can choose to pay themselves in the way they choose. In this case, they have the right to work through a limited company if this is the most effective way for them to handle liability.

Does a Contractor Inside IR35 Receive all Employee Benefits?

Contractors inside IR35 are legally required to pay income tax and contribute to National Insurance as listed above. Employers must be aware of this and make the necessary employee and employer deductions.

However, contractors inside IR35 only automatically receive some employee benefits. Currently, the law only refers to taxation. Therefore, employers are not obliged to provide statutory worker rights such as paid leave, worker benefits, etc. While they may not receive employee benefits, contractors maintain their autonomy, controlling when and where they work.

What Happens When a Contractor is a ‘Deemed Employee?’

What happens if you discover that a contractor previously operating outside IR35 is a deemed employee?

A contractor seen as having violated IR35 by not paying the relevant taxes may receive penalties. They will be required to pay unpaid taxes with interest from as far back as six years.

A business working with a contractor may also face financial penalties. Companies should be prepared to repay taxes with interest along with fines. During 2021 the government offered some leniency, stating it would not enforce penalties for those who violated the law by accident. If found to have intentionally broken the laws, punishments and public condemnation may be enacted to encourage adherence to the new legislation.

How Can a Status Determination Statement (SDS) Help?

An SDS, or a Status Determination Statement, is a document that a company must produce for each contractor they work with that operates through an intermediary. This will determine their employment status and help businesses comply with IR35 legislation.

An SDS should include the following information:

  • The decision made by the company on the contractor’s IR35 status
  • The reason for the decision
  • Evidence of ‘ reasonable care in deciding

The SDS should be handed to the contractor and any organization you contract with. You should keep records of contractors' statuses and the services they provide you and track any payments. Creating company protocols based on the SDS is ideal for helping you navigate any disagreements that may arise. If contracts or employment relationships change, you must also update and reissue SDSs.

What if the Contractor Rejects the IR35 Status Decision?

What if a company makes an SDS decision, but the contractor disagrees?

Contractors have the right to appeal an SDS decision verbally or in writing within 45 days of it being issued. The company then has a further 45 days to respond. Here a company can maintain its decision and clarify its reasons to the contractor. Alternatively, they can alter and reissue the SDS based on the appeal.

Companies must be careful to respond within the allotted 45 days. Please do so to ensure the company becomes responsible for paying the tax and NICs incurred by the contractor due to the status change.

What is ‘Reasonable Care in the Eyes of IR35?

The HMRC states that companies must be able to prove reasonable care was taken when determining a contractor’s SDS status. But what exactly does this mean?

Although HMRC recognizes that companies can vary greatly, examples of taking reasonable care include:

  • Keeping accurate records of employment status principles
  • Using the HMRC Check Employment Status for Tax (CEST) tool
  • Contracting advice from professionals
  • Reviewing and amending processes
  • Making new status determinations if worker relationships change

When looking into your worker’s status, consider whether they work for multiple clients or solely for you. Whether their work practices differ from your employees or the contractor assumes financial risks, it is essential to consider each contractor’s case individually.

What is the CEST (Check Employment Status for Tax)?

We mentioned the Check Employment Status for Tax (CEST) tool above. This is a helpful tool created by HMRC for companies that need to make IR35 status determinations on their contractors. If you ensure that all the information you enter into the tool is accurate, the HMRC will accept the decisions generated by it. Using this tool can contribute towards ‘reasonable care.’

You can use this tool if you are a:

  • Hirer
  • Agency
  • Worker

How to Stay Compliant After IR35 and Still Pay Contractors in the UK

Staying up to date with all UK employment laws is vital to hire, managing, and paying contractors compliantly.

It would help if you understood the following:

  • Worker classification
  • Employment benefits
  • Employment laws
  • Payroll practices

Keeping up with unique local laws can be overwhelming if you work with multiple contractors, especially in various countries. That’s why a global employment and payroll platform like Skuad can handle compliance. Skuad can help you legally hire contractors globally, create compliant IR35 contracts, abide by changing employment laws, and track, manage, and make all payments from one platform.

If you work with contractors, the consequences of the IR35 law changes can seem scary and complicated. But this should continue your business from working with UK contractors. These changes aim to change tax loopholes rather than make it more challenging to work with contractors.

Whether you are thinking about working with UK contractors or already are and may be impacted by the IR35 laws, check out how Skuad can help you manage compliance and contractor payroll.

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