What is IR35?
The IR35 regulations are designed to ensure that workers operating for 'intermediaries' – usually personal service companies – generally incur the same income tax and the National Insurance Contributions (NIC) as an equivalent employee. The initial press release reporting these rules was entitled with Inland Revenue Budget Press Release No. 35 – thus the rules are known as IR35. Another reason for introducing IR35 was to take away the tax benefits of individuals providing services in a limited company that is not solely in business on their account. According to the HMRC, the idea behind the legislation is "to ensure that individuals who work effectively as employees pay the right amount of tax." However, there are some changes made to the off-payroll working rules (IR35)for clients that must be taken into consideration as the IR35 liability has amounted to over£1million in recent cases, as the stakes are high.
When is IR35 Coming into Effect?
On 6 April 2021, the changes made to the public sector in 2017 will be extended to the private sector. From that date, medium and large private sector companies would be responsible for deciding the job status of the contractor's assignment, deducting any employment taxes due, for paying any tax owing to the HMRC.
If your business employs contract workers, getting ready for the next IR35 tax reform would be important to minimize market risk.
IR35 Changes April 2021:
- The changes are intended to increase the Treasury's revenue from National Insurance contributions. Download your guide to National Insurance Contribution here.
- It is now the responsibility of the company or client who hired the contractor to decide if the contractor is 'inside IR35' or works 'outside IR35' (Originally it was the contractor's responsibility)
- Before this, only the public sector businesses had to ensure the appropriate IR35 status of the contractors, as of April, it will be the responsibility of the private sector businesses as well.
- Laws for the participation of individuals by personal service providers or other intermediaries are changing.
- Accountability for finding out if the off-payroll rules (IR35) applied will be moved to the company receiving the services of the individual.
It is imperative for you to understand:
- The impact of the changes on your organization
- Actions that you may need to take before the amendments arrive.
However, before applying the new rules check the HMRC support to have a comprehensive understanding of it. Finance, HR, and recruitment departments would also need to consider the changes.
HMRC states that the regulations apply if a worker provides services to a client by an intermediary but would be treated as an employee if they were directly contracted. Since the laws may be complicated, we have tried to make things easier to say whether you are impacted or not.
If the following applies to the assignment of the contractor, the IR35 rules must be interpreted as follows:
- The contractor shall personally perform the work for the client.
- The workers are not contracted directly to the client (these laws shall not refer to sole traders)if they are using an 'intermediary' such as a personal service (PSC) or a recruitment agency.
- However, the worker will be regarded as an employee of the client for tax purposes if they would be contracted directly to the client.
In order to have comprehensive knowledge before applying the new rules, you need to know about the steps mentioned by the Government you might need to take.
Employees in a business must pay National Insurance at a rate of 12% for income between £9,500 and £50,000, and 2% for salaries over this, with companies still paying 13.8% on payments over the £9,500 threshold for any job on their payroll.
IR35 for Self-employed contractors, on the other hand, pay class two NICs of £3.05 a week on earnings between £6,475 and £9,500, class four contributions of 9% up to £50,000, and 2% on earnings over this.
This results in a lower tax bill than if they had been employees.
Employers are also not expected to pay contributions for self-employed workers.
Will self-employed be affected by IR35 changes?
According to the government, IR35 would not concern those who work as legitimate freelancers.
Instead, it is primarily aimed at contractors who create a Personal Service Company (PSC) and use it for their business. Some contractors will employ their clients and compensate the PSC, which will then pay the contractor.HMRC argues that some of these contractors should be considered employers and therefore incur the same rate of tax.
Small business exemption to the new IR35 rules
The Exemption, as defined by the Companies Act 2006 to the new IR35 rules for Small businesses should meet two or more criteria:
- Annual turnover should be under £10.2 million
- The Balance sheet total must be under 5.1 million
- The number of employees should be under 50.
If the end client satisfies two or more of these requirements, the responsibility for deciding the IR35 status of the assignment rests with the PSC, the amendments do not apply.
Check your employment status
Next, there would need to be a review of the contractor's employees and an audit carried out to assess the status of existing contractors operating under PSCs. This can be done by using the most common tool HMRC's CEST (Check Employment Status for Tax) for the status determination of whether someone is a “deemed employee” or not. Depending on the provided information, the HMRC will accept the CEST determination. Organizations should also educate their employees to understand the incoming developments and why they are so relevant to the company. The clients should take time to assess the real expense to their company of the possible increased payroll pressure. The additional cost of tax liability may show that too many contractors are not economically feasible under the new regulations. Alternatively, it can result in a simpler change by which clients treat workers as independent workforce rather than employees.
Conclusion & Our Experts' Advice for Contractors;
From 6 April 2021 onwards, if a contractor delivering services through a PSC is a "deemed employee" for tax purposes, the fee would have to be processed through payroll. This would cause an imminent financial effect – the payment of 13.8% of the employer's National Insurance Premiums and 0.5% of the apprenticeship tax in addition to the payment to the PSC.
This is likely to trigger new trade agreements between contractors/PSCs and clients. Contractors will not want to risk profits and consumers will not want to pay maximum expenses in comparison to the original fee. Failure to delegate responsibility would automatically mean that the responsibility rests with the company paying the invoice to the PSC – it could be the client or the group down the supply chain. HMRC developed the CEST method after initial feedback as it was not adequately precise. Many organizations have assured that they expect it will improve. In certain cases, however, the findings provided by CEST are accurate, if not appealing to either the contractor or the company due to the increased costs. We suggest that the parties sincerely apply their minds to improve the way projects are implemented and determine who bears the risk/requirement to execute the project if they wish to ensure a clean CEST health bill. You (clients) should take time to understand the potential additional payroll pressure on your company as true costs. The added expense of tax liability may show that too many contractors are not economically feasible under the new regulations. Alternatively, it can result in a simpler change by which clients treat contractors as independent workforce rather than employees.