To understand IR35, it’s useful to look at ways a worker can engage with a client, and there are generally 2 options:
- option 1 – be an employee of a client
- option 2 – work for a client through an intermediary vehicle. In practical terms this is through a Personal Service Company(PSC) or your own limited company
Under option 1, income tax and National Insurance Contributions (NIC) are withheld from that employee’s pay through the PAYE system, and the client, as an employer, pays Class 1 NIC on the employee’s wages.
Under option 2, more tax planning options are available. For example, the worker could pay himself a dividend out of the company’s profits, which is then reported on his self-assessment tax return. Not only are dividends taxed at a lower rate of income tax compared to employment income, but dividend distributions are generally not subject to NIC (note that employer’s NIC is also not applied on payments to companies).
Under option 2, a worker who is, in essence, an employee of a client, could avoid paying the same amount of income tax and NIC due for an employee by contracting with the client via an intermediary vehicle, such as a PSC. The IR35 legislation was brought in to combat this mismatch. In short, it looks past the existence of the intermediary and considers whether a worker would be considered an employee of a client for tax purposes.
Currently, in the private sector it is the contractor’s responsibility to determine whether IR35 should apply to an engagement, but this is about to change from April 2020.
From 6 April 2020, medium and large-sized businesses (defined as “clients”) will be responsible for determining whether an engagement falls within the remit of IR35 where an individual provides services through a Personal Service Company (PSC) or other intermediary vehicle.
Where a client finds a contractor to be within IR35, the relevant amounts of income tax and NIC are to be withheld by the fee-payer (typically the end client, but it could be a different entity, such as an agency).
Note that, for small-sized businesses, it will remain the contractor’s responsibility to determine whether IR35 should apply.
Definition of medium and large
There are two different tests that are used to determine a business’ size. A private sector company should be considered medium or large if it meets two or more of the below conditions:
- an annual turnover of more than £10.2 million
- a balance sheet total of more than £5.1 million
- more than 50 employees
For unincorporated businesses, a simplified test is applied to determine size. Under the simplified test, having an annual turnover of more than £10.2 million is enough to qualify as a medium or large business.
Introduction of the Status Determination Statement (SDS)
The reforms also introduce the Status Determination Statement (SDS). The SDS is a document provided by a medium or large client to a worker that informs the worker about whether the client considers them to be a “disguised employee”.
If a worker disagrees with an SDS, then there is the possibility to appeal through a client-led process. During an appeal, a client is given 45 days to respond, and two outcomes are possible. Under the first outcome, the client reviews the SDS and informs the worker that the SDS will remain unchanged as the status is considered correct. Alternatively, the client should issue a new SDS.
Unfortunately, the draft legislation that outlines how the reforms are to be implemented is poorly written and very difficult to understand. This, combined with a lack of detailed guidance from HMRC to date, means that a few practical issues with the reforms have been raised by the wider tax and accounting community.
1. Knowing a client’s size
As the reforms only apply to medium and large-sized clients, small businesses are not required to apply the new reforms. This means that, for contractors that work for a small-sized client through a PSC, the responsibility for determining whether a contract lies within IR35 remains with the worker.
As a result, it’s important that contractors understand what size entity they are contracting with. This may mean writing to your client directly to ask them to confirm their size, as it may not always be readily apparent.
2. Appealing an SDS
Additionally, it’s worth noting that the legislation, as it currently stands, only outlines how long a client has to respond to a status determination appeal. This means, technically speaking, there is no set time limit on when a worker can appeal an SDS.
The draft legislation may change and introduce a time limit for workers to appeal, but even if it does not, it would still be considered best practice to try and appeal any SDS within a reasonable timeframe (for example, some professional bodies have suggested a 45-day appeal period for workers once the SDS has been received).
3. The risk of blanket SDS decisions
During the consultation process for the off-payroll working reforms for the private sector, concerns were raised that clients may use blanket determinations to decide whether engagements are within IR35. The government, in its response to the consultation, outlined that all organisations are required to take reasonable care in making their decisions, and that a failure to take reasonable care can invalidate an SDS.
While the possibility remains that some clients may still adopt a blank determination approach (for example, HMRC says that “applying a decision to a group of off-payroll workers with the same role, working practices and contractual conditions can be appropriate in some circumstances”) it’s worth noting that, even if this does occur, there is the potential for a worker to challenge the SDS via the appeals process.
Although the reforms aren’t due to come into effect until April 2020, there are steps that contractors can take now to get ready for the upcoming changes.
Get familiar with the underlying IR35 legislation
Although the private sector reforms will bring about a substantial shift in the IR35 landscape, it’s important to note that the reforms do not change the underlying IR35 legislation.
Consequently, it’s vital that contractors who operate through a PSC understand:
- the basics of the IR35 legislation
- when an engagement may fall within the remit of IR35
- when a contractor is responsible for determining their own IR35 status, and when that responsibility is the client’s
While contractors shouldn’t be expected to understand every aspect of the legislation, as IR35 is a notoriously difficult area of tax, it is worthwhile understanding the basic hallmarks of an IR35 engagement, including areas such as control, mutuality of obligation, and the right to substitution, among others.
Equally, it’s worth speaking to a qualified accountant or tax adviser to get advice specific to your situation if you think that IR35 may apply to one or more of your contracts.
Make use of HMRC’s CEST tool
HMRC has developed a Check Employment Status for Tax (CEST) tool that, when completed, provides HMRC’s view as to whether IR35 is likely to apply to an engagement. Although the tool has its flaws (for example, it has only currently given a determination in around 85% of cases) it is likely that many clients will use CEST to determine whether a worker’s engagement should be treated as being within IR35. This is because, according to HMRC’s website, “HMRC will stand by the result given unless a compliance check finds the information provided isn’t accurate.”
As a result, if you’re a contractor it’s a good idea to run your own engagements through the CEST tool to see what determination is reached, as you should then have an idea of whether you are likely to be considered a “disguised employee” for a client and can plan accordingly.
Review contracts to see which may be affected
Where a contractor has contracts with different clients, it may be worthwhile reviewing existing and potential future contracts to see:
- which contracts should fall within the scope of the new reforms (i.e. the responsibility for determining IR35 status will fall to the client)
- which contracts will remain outside of the new rules (i.e. because a client is considered small, the worker remains responsible for determining IR35 status).
It may be helpful to engage the advice of an accountant or tax adviser to assist with any reviews.
Think carefully before disincorporating
Bodies such as the Low Incomes Tax Reform Group (LITRG) have previously raised concerns that, as a result of the private sector reforms, some contractors may end up disincorporating and be pulled into other working arrangements.
Disincorporating is not a decision to be taken lightly, as it can trigger its own share of tax issues, which can quickly become a headache if not dealt with properly. If you are considering changing your business structure as a result of the off-payroll working reforms, you should speak to AccountsNet before taking any further action, as it may be that your best course of action is to retain your PSC.