If you are a self-employed contractor or freelancer working through your own company, you may have heard of “IR35”. But do you know about the new “Off-Payroll Working Rules”?
The new rules are intended to ensure that many more such contractors are moved onto the payroll and will apply from 6 April 2020.
What is ‘IR35’?
Individual contractors in the construction industry often provide their services through their own company. Such one-man/woman companies are sometimes referred to as “personal service companies” (or “PSCs” for short).
Structuring your business through a PSC in this way can have obvious advantages. One well-known advantage is that it can help to limit the owner’s liability. Another key advantage in many cases (and the focus of this article) is the ability to structure payments through the company to pay less tax.
Such arrangements are, of course, legitimate for genuinely independent businesses. For over 20 years, however, HMRC have been concerned about such structures as a method of avoiding employment taxes. They are concerned that routing work through an intermediary company can allow individuals, who would otherwise pay tax as employees, to disguise such a relationship and to avoid income tax and national insurance.
As early as 2000, Gordon Brown (the then Chancellor) introduced IR35. This set of rules seeks to tax individuals as employees on the basis of an ‘imagined’ employment contract. Under IR35, HMRC are entitled to look at the relationship without a PSC in place between an individual and end-user (such as a large construction company). Effectively the evaluation involves ‘crossing out’ the individual’s PSC company for tax purposes. Under IR35 HMRC then ask if the relationship that emerges, minus the company, would be an employment one. If so, they should be taxed as employees.
Ultimately IR35 rules seek to ensure that where individuals provide their services like employees, an equivalent amount of tax and National Insurance Contributions (NICs) is recovered regardless of the structure an individual works through.
Those that are genuinely self-employed are not intended to be caught by the IR35 tax rules (although the borderline can be difficult to evaluate, and can lead to disputes with HMRC before a tax tribunal).
The current position (pre 6 April 2020)
Currently, in the private sector, an individual’s intermediary/PSC is responsible for determining its own employment status. It decides whether the IR35 rules apply. The tax risk of determining the self-employed contractor’s employment status also lies with a PSC (and therefore, in practice, with any sole contractor/owner).
Under IR35, to determine the contractor’s employment status, the contractual documentation between the parties needs to be assessed together with the day-to-day reality of the working arrangement.
For example, HMRC will look at:
(i) whether there is a requirement for the contractor to provide a personal service (or if they have a right of substitution);
(ii) the degree of control between the contractor and the ultimate end user or client;
(iii) the wider context and commercial reality of the relationship.
The proposed changes – 6 April 2020
From April 2020, the Government is set to introduce changes to IR35 in the private sector. These are known as the “Off-Payroll Working Rules”. The Government is taking this step (following similar changes in the public sector three years ago) as it believes that in up to 90% of cases, the IR35 rules are being applied incorrectly.
Under the proposed changes, it will be the end user or client company who now becomes responsible for assessing IR35. Before, using an individual contractor’s services (or before first supply) the client or end user (such as a large construction company) is required to assess if IR35 applies to the contractor or freelancer and their PSC.
From April 2020, where an end user/client engages a contractor through an intermediary/PSC, it must first demonstrate that it carried out due process to determine whether the contractor is genuinely self-employed or should, for tax purposes, be classed as an employee. The risk of such tax will remain with that client (corporate end user) if it fails to do so, or if it fails to take reasonable care in its assessment.
In order to assist businesses with status determination, HMRC has provided an online assessment tool to ‘Check Employment Status for Tax’ (“CEST”). This tool can be completed by the contractor or the end user. Some users have been critical of the tool, however, as it inevitably simplifies some aspects of the ‘employment’ test.
For each relationship, a business must (once it has assessed the position) also provide an IR35 ‘Status Determination Statement’ when assessing the IR35 status of contractors. A Status Determination Statement confirms in writing whether the end user considers the contractor to be an employee of the business for income tax purposes, and it will explain the reasons for the decision.
Who will be affected?
The upcoming changes will apply to all medium and large businesses within the construction sector using contractors.
HMRC classes a business as medium-large if it has two of the following: a ‘turnover of more than £10.2m, a balance sheet total of £5.1m, or more than 50 employees’. Smaller construction businesses that engage contractors through a PSC will not be affected.
Tips for preparing for the reform
Ultimately, the earlier you start to prepare for the changes, the better.
With only a few months to go until the new rules are extended to the private sector, businesses and contractors should be considering the potential impact. There are some obvious ways that you can prepare for the changes, regardless of where you sit on the supply chain.
It is a good idea for businesses to undertake an audit of their workforce in order to highlight relevant individuals that may be affected and to identify their status. Individuals will want early clarity of the evaluation procedures construction companies intend to apply to them and their PSCs.
HMRC’s CEST tool may be helpful in both cases.
During the IR35 reform, communication is essential. It is vital that businesses and contractors maintain clear communication throughout the process and encourage honesty throughout the supply chain to minimise the risk of any issues arising.
If you are interested in any of the topics raised in this article, have any questions or would like to receive further information, please contact a member of the Employment Team by calling 0115 9888777.