The ‘IR35’ Rules came into effect on Tuesday, 6th April 2021. From that date the way many contractors pay tax changed.
The main aim of the IR35 Rules is to prevent the avoidance of tax and national insurance contributions (NICs) through the use of personal service companies and partnerships.
The rules will not prevent contractors from working through either their own personal companies or a partnership. However, they do aim to eliminate the possible tax advantages of doing so.
The tax benefits generally arise when contractors take out the net taxable profits of the company by payment of dividends. This ensures that the contractor will not pay any national insurance contributions (NICs) which would generally have been due if that individual had been paid a salary or a bonus from the company’s profits.
The rules aim to tax most of the company’s income as if the person doing the work was paid a salary by the company (i.e. as an employee). Under the new rules the onus is now on medium and large-sized companies to assess whether work done by contractors and how they carry it out make them employees. If it does, they would now have to go under the PAYE system, and pay broadly the same income tax and national insurance contributions as individuals directly employed by the company.
But it is not all doom and gloom! A classification as an employee would mean that the erstwhile contractor would be entitled to company benefits such as sick pay, a pension and holiday pay.
Who falls under the Rules?
The rules apply to people working as self-employed via a company or partnership, who if they had been engaged directly by the company or partnership to do the same or similar work would have been classified by HMRC as an employee instead of self-employed.
For instance, a person working through a limited company but on a full-time basis for the company and who is subject to company rules in almost all aspects of the work is likely to be classified as a worker/ employee rather than as self-employed and would be caught by IR35.
As a rule of thumb, any contract which has striking similarities to a contract of a permanent employee and employer is likely to be held to fall inside IR35.
What are the implications of being inside IR35?
If you are caught inside IR35 the main implication is that you will be liable for full tax and national contributions as opposed to using the traditional planning techniques (small salary and high dividends) to minimise your tax obligations if you are outside. This means that you will be taxed in the same way as a permanent employee.
You will also need to calculate a deemed payment – this is your annual turnover minus your 5% allowance for the running costs of your company. The deemed payment is treated as if an actual payment had been made by the company on 5 April.
Tax and NICs must be paid to HMRC by 19 April.
Final RTI submissions showing details of the deemed payment must be submitted to HMRC by 19 April.
What are the implications of being outside IR35?
If your client deems your contract to be outside IR35 you can continue to operate via your personal service company and pay tax in the same way as you have previously done.
Points to consider
Consider what the difference will be to your net income and decide whether you want to continue operating through a company.
If the client wants you to continue as a limited company will the client pay you an increased fee?
If you continue as a limited company, you need to look at your future company income and expenses to ensure that you are not overly taxed.
Many businesses have had time to prepare for the new rules and have restructured their contracts, payroll and management and considered changes to the individual workers way of life and their flexibility.
All businesses should be aware of the possible repercussions, one of which is an increase in the tax your business would pay and an investigation by HMRC if you remain non-compliant.
You should also consider protecting yourself with IR35 insurance to cover the costs of professional representation and tax liabilities in the event of a tax investigation by HMRC.
How do I know whether my contractor falls under the Rules?
The regulations that surround whether a contract falls inside or outside IR35 are complex. Much will depend on how the contract is drafted and more particularly on the reality of your consultant’s working situation and work practices. HMRC will review your working practices and contracts to determine whether a contractor is an employee or self-employed.
In order to ascertain whether an individual should be a “deemed employee” the legislation requires that the employment status test is used. The IR35 status is ascertained by looking at whether the engagement would be one of employment or self-employment in the absence of the service company.
The first question to ask is whether your contractor is in reality an employee or self-employed.
The dividing line between employment and self-employment is thin. In determining whether a person is an employee or self-employed the courts look at several factors but overall, it is the intention and reality of the working relationship that matters.
Factors that the Courts and HMRC will consider
The factors that the courts consider when arriving at a decision on the status of an individual are as follows:
Control – who has control over the work done, the hours worked etc? Control concerns what has to be done, when and where it has to done and how it has to be done. In an employment relationship, the employer tells the employee what has to be done, when and where it has to be done and how it is to be done. If the client can move the contractor according to their priorities or exercise significant control over how they perform their duties (through supervision, monitoring, checking and appraisal) as opposed to the contractor maintaining autonomy over these matters then the contractor would be seen as employed rather than self-employed.
Equipment & Financial risk – Workers that are permanently employed by a company will rarely take a financial risk to be at work. However, as a separate entity a contractor may have to purchase their own equipment eg laptop, computer, books, construction tools, indemnity insurance etc. This feature is characteristic of self-employment. Does the employer provide the equipment? In some instances, the contractor is likely to be an employee, in others not.
Mutuality of obligation – is there an agreement between the parties that the employer will offer work and that the contractor will take up the work? If there is a clause in the contract or an expectation that the employer provides continuous work to the consultant with the contractor under an obligation to accept and complete the work (mutuality of obligation) this would be a characteristic of an employment relationship and the contract will be caught by the IR35 legislation. Contracts that are continuously renewed or “rolling contracts” could therefore be caught by the IR35 legislation.
Right of Substitution – can the contractor send a substitute to do the work if she is not available or must the consultant do the work herself? The need for one particular person to carry out a role is an essential element of a contract of employment. It therefore follows that a contractor who can choose whether to perform their duties themselves or engage somebody else to do the work for them (on a reasonably unsupervised basis) is self-employed.
Company perks – is the individual entitled to employee benefits such as training courses, sick pay, holiday pay, pension contributions, annual staff parties etc? If so the contractor is likely to be an employee.
Notice period - permanent employees will usually have a notice period. As a contractor the client will generally have the option to terminate the contract immediately if they wish.
Need more advice?
How Can Pure Business Law help?
The rules surrounding IR35 are not always easy to follow. It is essential to get good legal and accountancy advice.
We always recommend that our clients consult with their accountants on the operation of the IR35 Rules and on the tax implications. Alternatively, we can refer you to one of our partner accountants for specialist accountancy advice at reasonable fixed fees.
We are fixed fee specialist employment law solicitors based in Bedford and London. We operate nationally. If you would like to discuss any employee issue or require the drafting of employee contracts, Handbooks or policies for your staff or anything else raised in this article or on our website, please contact us and speak with one of our specialist expert employment lawyers. We are waiting for your call.