IR35 – what you need to know
The aim was to combat a specific form of perceived tax avoidance – “disguised employment” where, as HMRC put it, it was “possible for someone to leave work as an employee on a Friday, only to return the following Monday to do exactly the same job as an indirectly engaged ‘consultant’ paying substantially reduced tax and national insurance”.
Perhaps the most famous example was John Birt, ex-Director-General of the BBC, who, under political pressure and public opinion, converted to a more conventional employment relationship in the mid-1990s.
The press release went on to say that “the proposed changes are aimed only at engagements with essential characteristics of employment……. There is no intention to redefine the existing boundary between employment and self-employment.” That may bring a wry smile or two now.
IR35 obliged a personal service company (or other intermediary) to:
- determine if an individual providing services through it would be an employee of an end-user client, but for the existence of the intermediary; and, if so
- account for income tax and employer’s/national insurance contributions on the fees paid by the client for the services as if they were earnings of the individual
No longer could an individual pay themselves through tax-advantageous dividends from the intermediary.
Despite its professed noble aims – ensuring that individuals who work no differently from employees but provide their services through an intermediary pay their fair share of tax – IR35 has been criticised for its complexity; burden on small business; causing contractors to pay more tax than employees and lack of efficacy in increasing tax revenue.
Off-Payroll Working Rules
Despite this criticism, HMRC’s perception of large-scale tax avoidance continued. It seems to have believed the legislation lacked teeth. After all, it was asking individuals to collect their own (increased) tax. HMRC estimated that only 10% were operating IR35 correctly.
Far better if the onus to collect tax was put on someone with no vested interest – the client. And so the off-payroll working rules were introduced in April 2017, disapplying IR35 where the individual’s services were supplied to a public sector client. This moved the burden of determining employment status for tax-purposes from the intermediary to the client. Likewise, the responsibility for collecting and accounting for any income tax and national insurance contributions moved to the client. It was envisaged that many public sector clients would either insist individuals became direct employees or deduct tax as if they were. It is not clear, however, that this has yet had the impact HMRC desired.
Nevertheless, these rules are now being extended to the private sector. This was due to happen in April 2020, but was delayed to 6 April 2021 because of the Covid-19 pandemic.
Only clients who are small companies escape. A small company is any in its first financial year and, after that, if at least two of the following apply:
- annual turnover not exceeding £10.2m
- balance sheet total not more than £5.1m
- average of no more than 50 employees for the financial year
It is estimated that 60,000 organisations in the private sector engage with individuals through intermediaries and will be affected by the changes; as will 170,000 individuals who work through intermediaries.
Determining Employment Status
There is no statutory test or one absolute indicator to determine employment status for tax purposes. It is a case-by-case application of factors established by previous legal cases and requires analysis of any written contract and the practices and conduct of the parties. A written contract is not necessarily conclusive.
Crucially (and some would say surprisingly) IR35 allows HMRC to look through any actual contractual documentation in place, instead focussing on a hypothetical contract between the end-user client and the individual.
HMRC has an online tool to “Check Employment Status for Tax” (CEST) to help clients make an employment status determination and which demonstrates the indicators on which HMRC relies, including:
- whether the individual can provide a substitute
- the level of control exercised over the performance of services by the client
- the financial risk taken by the service provider
- who provides equipment used in providing the services
- the level of integration of the individual into the business of the end user
- if the individual is in business on their own account
- if there is both an obligation to provide work and an obligation to perform that work
CEST has been much criticised and does not have the force of law, but HMRC has confirmed that if it is used properly and gives an “off-payroll working rules (IR35) do not apply” result, it will accept that result. In practical terms, such a result will be critical evidence in the event of a dispute over employment status.
The extension of the rules to the private sector has generated a great deal of uncertainty for contractors (as those who supply their own services through an intermediary are generally called) and clients alike. That uncertainty has been exacerbated by putting back its introduction by a year. It is not beyond doubt that the continuation of the pandemic will not cause a further delay.
Will clients now insist on direct employment (or at least tax and national insurance deductions as if they were employees) for contractors? Will this push up salaries or rates as contractors look to minimise the effects of any change in status or deemed status? Will clients be willing to take the risk of not deducting tax but then been held to account for this by HMRC? The answers to these, and the many other questions that will undoubtedly arise, are likely to be market-driven and sector specific.
And if the new rules do not drive up the tax-take as anticipated, where next for HMRC?
First published in Insider North West